The Sky Could Very Well Be Falling: California’s Proposition 13 and Commercial Real Estate Taxes
California’s Proposition 13, a property tax reform ballot initiative passed in 1978 and credited for igniting a nationwide tax revolution, is being challenged by a coalition of groups advocating reform.
Proposition 13 is often referred to as the “Third Rail of politics,” meaning that it’s such a controversial and “untouchable” issue that most politicians won’t broach the subject for fear of political fallout. Proposed Legislation to change Proposition 13, specifically, the issue of a “split roll” in which commercial and industrial property would be annually or periodically reassessed, comes up regularly in Sacramento, and are quickly challenged by business advocacy groups and the Chamber of Commerce who typically lobby reform to a quick death, usually in committee. However, we are now entering uncharted waters on the split roll issue
Proponents of a split roll have put forth a ballot initiative called The California Schools and Local Communities Funding Act that has obtained the necessary signatures to place the initiative on the November 2020 ballot. This is different from past efforts, as the electorate — not the legislature — will determine its fate; the first commercial property tax reform initiative to qualify for the ballot since the passage of Proposition 13. The initiative could well be approved by an electorate younger and newer to California than that of four decades ago, even in the face of tens of millions of dollars of opposition advertising from the business community.
If passed in its current form, the tax roll of business and other commercial properties would be split off from that of residential and all non-residential real property would be reassessed every three years at current market value. Businesses operating on real property with a total value of less than $2,000,000 in fair market value within the state would be exempt from periodic reappraisal and maintain their Proposition 13 property tax protections, as would agricultural property. The initiative also provides for the exemption from tangible personal property taxes up to $500,000 in value, and in cases where the business has fewer than 50 full time employees, a complete exemption from personal property tax regardless of valuation.
Under Proposition 13 real estate assessed values were rolled back to 1975 levels, establishing a new Base Year from which the maximum annual inflationary adjustment in the assessed value is 2 percent plus any new construction. The Proposition 13 Base Year value maintains this course until which time there is a change in ownership or change in control of a legal entity that owns real property in the State of California. The change triggering a reappraisal of real property to current market value as of the event date, thus establishing a new Prop. 13 Base Year value, is generally a greater than 50 percent change in ownership or control, with some exceptions. There are many properties under long-term ownership throughout California, including commercial and industrial, whose factored Prop. 13 values are at a fraction of their current market value. These include those of many long-standing business enterprises critical to the state economy whose total real estate fair market value would exceed the proposed threshold to be exempt from regular reappraisal. The prospective property tax increases as a result of the implementation of a split roll would be very damaging to the viability of the affected business enterprises.
New values based on best use would generate new annual property taxes of $6.5 billion to $10.5 billion per year, depending on the strength of the real estate market, according to a Sacramento legislative analyst. Forty percent of that would go to the state’s schools, once among the nation’s best, now 41st in funding per pupil. That money would come largely from owners of commercial- and investment-grade properties that have been under the same ownership since 1975. Following are some of the core reasons that are fueling this uncertainty:
- Passage is going to trigger court action that is likely to last years. As an example, the Supreme Court voted 8-1 in 1992 to uphold Prop. 13, declaring it “the will of the people of California.” But it took 14 years to get the decision, and the court called the initiative “distasteful and unwise.”
- At a recent property tax conference representatives of the California Assessors Association told the California Alliance of Taxpayer Advocates that it would take at least five years to hire and train appraisers needed to meet demands of the new legislation. It calls for phasing in the new valuation, which would likely begin in the 2023-24 fiscal year and extend for two more years. Add the three-year phase-in to the likely court-challenge time, and it would be years before “The Act” has any impact.
In addition, California’s counties spend about $550 million on assessing their properties now. The new law would allocate hundreds of millions more to implement.
The burden of operating a business in California is already monumental with challenges too many to mention. The existence of Proposition 13 property tax protections remains the one safe haven for businesses owning real property in California, whether operating business enterprises or investor-owned entities leasing to members of the business community. Removing these protections would likely prove to be very damaging to California businesses and its economy as a whole.
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Scott LootsLootsbu-state-local-tax real-property-taxdevelopment-due-diligencefinancial-due-diligencesan-franciscoDirector, Property Tax
Last updated on September 4th, 2019 at 04:18 pm