Real Estate in the Time of Cholera: The Aftermath, Part 3 – The Taxman Cometh

I wrote a VIP post recently talking about the Durable investment into Redfin and what it signaled for the future of brokerage. But while writing it, I thought of something that deserves wider discussion. Here it is:

Furthermore, after the government response to COVID-19, I am reasonably confident that agent teams will be brought under the umbrella of labor laws of the various states. Why? We’re gonna have to find a way to pay for $2 trillion in emergency spending, and given the time crunch, the government decided to send the money out then figure it out afterwards. Well, when the afterwards comes, a lot of folks are going to be looking through all of the 1099 unemployment requests and look for tax revenues wherever it can be found.

Real estate brokerages are likely immune; agent teams are likely not.

More I think about this, more I believe it is inevitable. Our governments at all levels are spending like crazy in order to deal with the health crisis. That is likely appropriate given what we’re facing with the pandemic. But there ain’t no such thing as a free lunch, so eventually, we are going to have to find a way to pay for all this emergency spending.

Real estate will not escape unscathed.

State and Local Finances

The Associated Press has a story that is particularly relevant to this topic: state budgets are being wrecked by coronavirus.

The coronavirus is pounding state governments with a financial one-two punch, costing them millions to try to contain the disease just as businesses are shutting down and tax revenue is collapsing. The sharp drop in revenue could jeopardize some states’ ability to provide basic services.

States ranging from tiny Rhode Island to California, with the world’s fifth-largest economy, have warned that many programs are likely to face cuts or even elimination.

The numbers are staggering. New York, the hardest hit state, is expecting a drop of $15 billion in tax revenue. Virginia is looking at a $2 billion hit. California has a $20 billion reserve, but relies heavily on capital gains… and the stock market took a pounding in March and we don’t know when that will end. Ohio is looking at budget cuts of 20%.

The Federal government might step in with more aid, since the $150 billion in the CARES Act might not cut it. And what’s another couple hundred billion when we’re looking at trillions in emergency spending?

Nonetheless, we will see some cuts in services. How large depends on what happens.

But the other impact will be state and local governments trying to find more tax revenue. It’s natural and it’s what they have always preferred to do, rather than lay off government employees and cut programs.

Raising taxes, especially after a pandemic-induced recession/depression, is going to be difficult (if not impossible, politically speaking). They have to try to find ways to collect more taxes without raising taxes on the majority of voters.

The Routine Violation of Labor Law in Real Estate

Folks who know me know that I’m a Milton Friedman disciple when it comes to things like taxes and government. Less government is best government, IMHO. So it’s not like I want the .GOV to come trying to scrape nickels and dimes out of productive businesses. But this isn’t about what I personally want or do not want.

Because I can’t believe that semi-intelligent bureaucrats at various state and local governments are not already aware of the rampant violation of labor law in real estate, particularly in agent teams. They likely turned a blind eye to the whole thing because of the political power of REALTOR Associations, and it just wasn’t worth the fight when the economy is roaring. They know and have known for years.

In a previous post about California’s AB5, the so-called “gig economy” law, I wrote:

It seems clear to me that whatever exemption from the Dynamex ABC test was granted [by AB5] was granted only to brokers. Agent team leaders have no statutory duty to supervise and control the agents on their teams — indeed, I would argue that they have no statutory authority to supervise and control them. If they did, they would be brokers or at least managers under California law.

Yet, you know and I know and everybody and his grandmother knows (if she’s in real estate) that the team leader very much supervises and controls the agents on the team.

And longtime readers know that I have been talking about labor law and agent teams for years now.

You simply can’t exercise the level of control over “team members” that agent team leaders have and do and claim that they are “independent contractors.” And if you don’t exercise that level of control, then you can’t have a unified entity that makes the whole agent team concept work.

If this isn’t a big fat juicy target for state and local governments who are going to be looking for tax money under every rock, then I don’t know what is.

State governments in particular will be looking for tax revenues to offset spending on healthcare and unemployment — the two biggest areas during the pandemic. What are the two biggest taxes that teams didn’t pay by classifying their team members as independent contractors? Healthcare and unemployment.

It might not happen, of course, because politics. But I’d be surprised if it doesn’t.

Perception Is Reality

When this fight comes to the industry in a couple of years, how easy or difficult it will be for REALTORS to prevail will depend largely on public perception.

So let’s start by at least acknowledging where real estate agents stand in the list of most respected and least respected professions. Because this sentence will never be uttered by any politician anywhere in the country:

“Hey, we can’t possibly tax real estate agents! Just lay off some teachers and cops.”

Then we need to at least address the fact that most real estate agents constantly project the appearance of success: fancy cars, nice suits, expensive designer handbags, immaculately coiffed…. Those are all advantages in a sales-oriented business, because after all, what homeowner wants to list his most valuable asset for sale with someone who’s not real successful at his job? But those are disadvantages when it comes to pleading for exemptions from taxes or special considerations.

Other business interests at least can plead that they ought not to be taxed further, so they can use that money to hire more people. Real estate, not so much.

Finally, as an industry, we have spent the last few weeks pleading and urging and broadcasting all over social media that real estate is an essential business. REALTORS everywhere on my social media accounts are stepping up, talking about taking care of their communities, telling people to stay home, advising people on mortgage and rent forbearance rules, and so on. All of that is wonderful, of course, and we ought to acknowledge that REALTORS do a lot for their local communities.

The downside of all that, of course, is when local communities come knocking looking for tax revenues so they don’t have to lay off teachers, cops and firemen. “I’m all about my local community, but my bank account isn’t” is simply not going to fly, politically speaking. Not when unemployment is going to be at all-time highs.

So get ready today, because I think this is coming. Maybe not this year, but soon, as state and local governments keep staring at giant holes in their budgets.

-rsh

 

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Rob Hahn

Rob Hahn

Managing Partner of 7DS Associates, and the grand poobah of this here blog. Once called "a revolutionary in a really nice suit", people often wonder what I do for a living because I have the temerity to not talk about my clients and my work for clients. Suffice to say that I do strategy work for some of the largest organizations and companies in real estate, as well as some of the smallest startups and agent teams, but usually only on projects that interest me with big implications for reforming this wonderful, crazy, lovable yet frustrating real estate industry of ours.

3 thoughts on “Real Estate in the Time of Cholera: The Aftermath, Part 3 – The Taxman Cometh”

  1. Taxes can sound scary but it would be interesting to see how much more taxes as a net would be collected if all team members are required to file as w2 exempt or non-exempt. Especially when considering the additional coverage that would have to be offered to those employees and the nature of real estate being seasonal work for many agents and the huge failure rate of many new agents. These agents currently don’t cost much to the general tax system, they just have to go into a different field or work when they can. I also wonder if it would just be more effective to accurately audit current 1099 tax returns rather than force many to join the w2 ranks. Also, this new way to work would be a huge deal if the current system remains intact and only the tax implications are added, another scenario is that the industry would also shift along with the tax policy to comply but maintain profitability.

  2. This situation that we are all experiencing is a great wake up call to how fragile our economy is. I like what you said that it’s all about perception. If we can keep everything in perspective and not let this get the better of us, I think we will all come out on top. Especially Realtors.

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