Assembly Bill No. 2372 (the Bill) proposes to make changes to California's Proposition 13 which governs property taxes. The changes are primarily directed at commercial real property owned by one or more entities.

Proposition 13 generally limits taxes on real property to one percent of the full cash value of that property. “Full cash value” is defined as the assessor's valuation of the property tax bill, which typically is based upon the purchase or construction price of the real property, unless there is a reassessment. Under the current law, commercial real property generally is not subject to reassessment unless a “change of ownership” occurs.

Under the current law, a “change of ownership” may occur upon certain transfers of ownership interests in legal entities which hold title to real property located in California. In that context, “change of ownership” generally means the transfer of more than 50 percent of the ownership interests of a corporation, partnership, LLC or other legal entity to a single new party. A “change in ownership"” also occurs where less than 50 percent of the ownership interests in an entity are transferred, but where, by way of such transfer, a single entity ends up with more than 50 percent of the ownership interests in the entity that owns the real property.

As a result, it has become common practice to carve up ownership interests among multiple parties so that no single party has a majority interest. Doing so permits transfers of ownership interests without triggering a reassessment. Because the transfer of membership interests generally does not involve the recordation of a document in the real property records, even when a “change of ownership” does occur, many go unreported and the tax assessor often does not discover the change in ownership.

The California Legislature, in an effort to capture missed tax revenue, wishes to use the Bill to make it increasingly more difficult to avoid reassessment. The Legislature has stated that it is aware that “property ownership may include complex legal maneuvers and methods of dividing up ownership. Often, changes in ownership take place that are not known to the tax assessor because they are deliberately obscured, for example, by keeping the property in the name of the old property owner after the company that owns the property is purchased.”

Under the proposed law, “change of ownership” would also include a transfer, directly or indirectly, of 90 percent of the cumulative ownership interests of an entity in one or more transactions, whether or not any one legal entity or person acquires control of the ownership interests. Multiple transfers of the same ownership interest are counted only once towards the 90 percent total.

This means that those engaged in the acquisition and development of commercial real property in California must carefully track the transfer of membership interests, not only of the entity that owns the real property directly, but also those entities with indirect ownership of the real property by way of holding membership interests in the entity or entities that hold title to the real property. Upon the cumulative transfer of 90 percent or more of the ownership interests, either in a single transaction or a series of transactions, the property would be subject to reassessment.

The Bill also would increase the penalty for failure to file a change in ownership statement with the Board of Equalization. The penalty would be increased from ten percent to 15 percent of the taxes that would be due as a result of a reassessment, plus additional penalties for non-payment. Further, in an attempt to ferret out efforts to conceal changes in ownership, the Franchise Tax Board will be required to include additional questions on the tax returns for partnerships, banks and corporations which would flag when a transfer of membership interests of an entity has taken place in the past year.

Because the Bill would result in taxpayer paying higher tax within the meaning of Article XIII of the California Constitution, it will require for passage the approval of 2/3 of the membership of each house of the Legislature. The Bill was approved by the Assembly on May 29, 2014 by a vote of 56-8. As of August 14, 2014, the Bill is being held under submission by the Senate Appropriations Committee. While not certain, it appears that the Bill currently has sufficient support in the Senate. If passed and not vetoed by the Governor, it would go into effect January 1, 2015.