Fire on the Horizon: Proposition 13 Property Tax Protection May be Razed by Proposition 15 for Commercial Real Estate in California
This November, Proposition 15 (2020), the "Tax on Commercial and Industrial Properties for Education and Local Government Funding Initiative" will be on the ballot in California and, if approved by voters, would amend the California Constitution to increase real property taxes for commercial properties throughout the state, partially repealing the limits set by Proposition 13 (1978). It is anticipated that Proposition 15 would generate between $8-12.5 billion per year for schools and local governments.
As with many things, to understand the future, we must look to the past.
Originally passed by California voters in 1978, Proposition 13, the "Tax Limitations Initiative," amended the California Constitution to cap real property tax at 1% of the "full cash value" of such property, based on the property tax rolls for 1975-1976. Thereafter, a property cannot be reassessed unless there is a "change in ownership," subject to an annual 2% adjustment. If no "change in ownership" has occurred since 1978, owners should be paying taxes based on the value of their property in 1975-76. One of the driving forces behind Proposition 13 was that older Californians with fixed incomes were having difficulty paying taxes as values rose dramatically and the population increased, resulting in tax liens being foreclosed and the loss of homes.
Proposition 15 would create a "split roll" under which most commercial properties are taxed at the current fair market value (FMV), which in many cases is dramatically higher than the assessed value owners have today under Proposition 13. However, there are exemptions and other benefits proponents say would offset the increased cost for owners.
Proposition 15 contains complete or partial exemptions for residential properties, agricultural commercial properties, "small properties" (generally, properties with FMV less than $3 Million) and mixed-use properties. However, there are significant limitations on such exemptions.
For example, with respect to "small properties," the $3 million cap applies in the aggregate to all beneficial owners. If any beneficial owner (direct or indirect) of a "small property" has beneficial ownership (direct or indirect) in other commercial property in California, all such property is counted towards the $3 million threshold, and if exceeded by any owner, the "small property" does not qualify for the exemption and is assessed at FMV. This is a continuing requirement of the exemption, meaning any changes to the ownership of the "small property" which exceed the $3 million aggregate cap would result in a loss of the exemption. Because a single beneficial owner could cause a dramatic increase in real property taxes, Proposition 15 likely would change the way funds are raised for commercial developments in California (including additional diligence, representations and covenants around ownership of commercial realty in California).
Mixed-use properties would receive a partial exemption, with only the portion used for commercial and industrial purposes being subject to Proposition 15 reassessment. While a 500-unit apartment project may be considered commercial realty for some purposes, Proposition 15 states that residential property includes multi-unit structures. Further, the legislature "may" allow a complete exemption for mixed-use projects which are 75% or more residential.
Proposition 15 is proposed to be phased-in to provide owners reasonable time to account for and pay the increased taxes. A percentage (to be determined by the legislature) of commercial properties within each County shall be reassessed starting January 1, 2022, with the reassessments to extend over two or more lien dates, and with the new taxes due as of the year the reassessment is complete. If 50% or more of a commercial property is owned by a "small business" (i.e., less than 50 employees, independently controlled and owns realty in California), the reassessment shall not occur until 2025 at the earliest (to be determined by the legislature). After the initial reassessment, commercial properties are "periodically reassessed no less frequently than every three years" (to be determined by the legislature).
Failure to claim an exemption or classification results in a waiver of the exemption for that year. This suggests a property might be able to go back and forth between Proposition 13 and Proposition 15 if it fails to claim an exemption one year, but does so the next. Valuation appeals are permitted, with the burden of proof on the owner.
One incentive under Proposition 15 is a significant exemption from personal property tax beginning in 2024. Small businesses would be altogether exempt from personal property tax, and all other businesses would receive a $500,000 exemption (in the aggregate, taking into consideration parents, subsidiaries and holding companies). Aircraft and vessels do not qualify for this exemption.
The anticipated $8-12.5 billion to be collected annually will first pay certain administrative costs of Proposition 15, with the balance split between school districts and community colleges (40%) and local governments (60%).
Proponents claim Proposition 15 is needed to preclude "tax avoidance schemes" whereby "large investors and corporations, many of whom are from other states and countries," have diverted funds away from schools and local communities, and suppressed small businesses. They claim that 80% of the tax savings under Proposition 13 go to 8% of commercial properties in California, and Proposition 13 incentivizes owners to hold vacant, idle property; whereas Proposition 15 would encourage development (albeit at higher cost).
Opponents of Proposition 15 claim that any increase in taxes will be shifted 100% to consumers, and without the assurances of Proposition 13, businesses will no longer desire to operate in California, causing greater financial harm in the long-term.
According to an April 2020 survey of likely voters by the Public Policy Institute of California, 53% support Proposition 15 while 47& oppose it (+/- 3.7%). California ballot measures require only a simple majority of the votes cast for or against them.