(Bloomberg) — In the past two years, every building except Margarita Gandhi’s real estate agency sold in Old San Juan went to a U.S. mainland or a foreign buyer. Each buyer cited Puerto Rico’s liberal tax breaks as the reason for the move.
External money inflows to Puerto Ricans – especially those who count their wealth in bitcoin, ether and other cryptocurrencies – have reached an all-time high. So is the frustration with a tax system that many locals say is fueling a real estate bubble that is making island life untenable.
“We used to have a vibrant community here,” said Gandia of the colonial city’s rocky streets and Spanish forts, where he has seen prices double or triple in just a few years. “Since we let people in without restrictions, we’re missing out on large parts of Old San Juan. Local Puerto Ricans can’t afford to live here.”
Meanwhile, on the streets of the capital, photos of wealthy cryptocurrency and real estate investors are visible with the caption: “This is what our colonists look like.”
At the center of the controversy is the “resident investor” incentive, commonly known as Act 22, which lures wealthy individuals with promises to legally reduce US federal income taxes. Once they are residents of Puerto Rico, they pay zero taxes on capital gains, dividends and interest, making it particularly attractive to holders of cryptocurrencies.
But those allowances aren’t available to people who are already living in a U.S. territory, where most people pay a capital gains levy of about 15% and the economy has been in recession for a decade.
“There is an issue of treacherous competition here,” Puerto Rico House Speaker Rafael “Tatito” Hernandez said last week, as he announced plans to examine all of the island’s tax incentives. “Local capital is not subject to the same rules. We have to control it.”
Read more: Puerto Rico’s economy poised for double shock in 2022
Proponents of Act 22 and other incentives say they are attracting a wave of tech-savvy mainlanders who are giving back to the community through their purchasing power, sales and property taxes and starting companies. Act 22 beneficiaries are also required to donate $10,000 per year to local charities and purchase a home.
The island needs all the revenue it can get. On Tuesday, after four years of ordeal, the government emerged from a record-setting bankruptcy that would require it to pay out about $3.4 billion a year to service its debt and the public pension system. And unless it finds new sources of income or kick-starts the economy, the government may start running the deficit again by 2035.
Meanwhile, Juan López Bauza, a writer and translator living in Old San Juan, said “the arrival of wealthy mainland people scouring real estate in Puerto Rico’s gloomy economy” feels like a land grab.
“Act 22 is a business of people buying properties and converting them into Airbnbs or betting on them,” he said. “They’re building it so I can’t even afford to live in my city, where I’ve lived for 30 years.”
According to the Federal Housing Finance Agency, home prices across the island have increased by 24% over the past two years. But in pockets popular with mainland investors such as Dorado, Condado and Old San Juan, values are skyrocketing, turning them into English-speaking enclaves of the ultrarich.
Many forces fuel the boom, including work-from-anywhere movement, chronic housing shortages and the explosion in Airbnb and short-term rental units, said Raul Santiago, professor of planning at the University of Puerto Rico.
But the stimulus is an easy target and fuels the belief that the government is preparing the red carpet for the mainland at the expense of the average Puerto Rican. “The incentives are incredibly unpopular,” Santiago said.
Sun, Fun, Tax Breaks
When the pandemic hit New York City in 2020, cryptocurrency trader Michelle Dong went looking for a new home. He toured Florida, Alaska and Hawaii before stumbling upon Puerto Rico.
Speaking on the sidelines of a cryptocurrency conference in December, Dong said the US territory of 3.3 million people offers a mix of colonial architecture and Latin charm that he found unique.
“Obviously, we are here for the taxes: so everyone comes here,” said Dong, founder and CEO of Pythagoras Investments, a crypto hedge fund that he says has $100 million under management. “But we immediately found a superfriendly expat and crypto community. We have a great social life.”
Puerto Rico’s economic development secretary, Manuel Sidre, said a distinction must be made between people like Dong who are building businesses or producing taxable income, and those seeking to avoid capital gains and dividend taxes only. Huh.
“If you come here just to buy a house, play golf and enjoy the weather, I don’t want you to pay zero tax,” he said. He suggested that the island could start charging some capital gains under Act 22 and still remain competitive compared to the mainland.
Read more: Zero Taxes, Golf and Mansion Make a Crypto Island Paradise
Like many jurisdictions, Puerto Rico’s tax incentives are designed to support strategic sectors such as manufacturing, healthcare, and tourism. Many newcomers are also taking advantage of incentives designed for service-exporting companies that offer a 4% tax rate compared to the island’s standard rate of about 35%.
As Puerto Rico emerges from bankruptcy, it is important to see if all the incentives are working, said Jesus Santa, the head of the Puerto Rico House Finance Committee.
“If the incentive is good, explain it to me, show me the numbers, but don’t come here with principles and philosophy,” he said. “We need to know which incentives should remain, which ones can be reformed and which ones need to be killed.”
Santa said that on an island that has lost 12% of its population from 2010 to 2020 — more than any other US jurisdiction — incentives could stop the demographic bleeding.
“For decades we have used our incentives to bring in people from abroad,” he said. “It’s not a bad thing, but we also have to work with people who are already here.”