Putting the Squeeze on Prop 13
Posted by GibbsGiden Under Business and Commercial Law
New ballot measure may force business owners to rethink their real property exposure.
Enacted in 1978, Proposition 13 established that real property taxes in California (whether on commercial, residential or industrial property) are based on the purchase price of the subject property. These taxes are generally limited to 1% of the purchase price of the property and are subject to an annual increase of 2% or the rate of inflation, whichever is lower. These limitations are often a boon to property owners since property tax liability is pegged to the owners’ cost basis instead of the property’s market value (which, apart from the aftermath of the 2008 financial crisis, has generally exceeded the purchase price).
The “California Schools and Local Communities Funding Act” proposes to nullify the effect of Prop 13 as it applies to most commercial and industrial properties. Two versions of the ballot measure have been proposed – 17-0055 and 19-0008. So far, the 17-0055 version has qualified for the November 2020 ballot.
While the two versions differ slightly, the thrust of the measure is the rescission of the favorable rules governing the assessment of commercial and industrial properties under Prop 13. If passed, the measure would amend the California Constitution to require periodic reassessments of most commercial and industrial properties to reflect their current market values. The measure would not affect residential properties.
The measure calls for an initial phase-in of the tax increase to ease the administrative burden on county assessors and taxpayers. Thereafter, subject properties would be reassessed no less frequently than once every three years.
A mandated reassessment frequency (or, more accurately, establishing a minimum baseline frequency) would be a dramatic departure from the existing Prop 13 approach, which generally requires reassessment only upon a change of ownership. Affected properties with suppressed taxable value (i.e. properties with market values exceeding their assessed values) could face potentially significant and unanticipated tax consequences. For landlords who pass property taxes through to tenants as operating expenses, the measure would pose a challenging dilemma. Forcing tenants to shoulder the tax burden of the new initiative could force some tenants to break their leases, decline to renew or force them out of business entirely. It could also adversely affect demand for the tenantable space, since would-be tenants might have to look elsewhere for affordable leases. Landlords electing to assume a portion of the new tax liability (which could adversely affect the marketability of the property and, consequently, its fair market value) would face diminished yield on their property investment, with operating cash flow being partially offset by new tax payments.
California is already home to a relatively onerous tax burden. Through June 2019, California voters had approved more than 800 new taxes on businesses and residents. At 13.3%, California also has the highest marginal tax rate in the United States for top earners. According to a study published by the Tax Foundation, California ranks third from the bottom on a list of states with the most business-favorable tax climates.
Despite low borrowing rates, any property tax increase could force businesses to reassess the merits of remaining in California. McKesson, Core-Mark and Jamba Juice uprooted their headquarters in favor of Texas in recent years, and Charles Schwab announced its intention last year to follow suit. While such moves are anecdotal and a function of several factors, including favorable regulatory climates, a property tax spike could change the “Cal”-calculus for many businesses – especially those with already tight margins.
Business owners may find comfort in the outcomes of the March 3rd ballot: California voters rejected more than half of the 237 local tax and bond measures proposed, including the new Prop 13 (not to be confused with the subject of this article), a $15 billion bond measure intended to support school and college facilities. Perhaps the March 3rd results augur well for business owners come November.
 Subject to certain supplemental taxes and ad hoc assessments.
 As measured by the California Consumer Price Index (“CPI”).
 Defined as “real property used or zoned as residential property, including both single-family and multi-family unit structures, and the land on which those structures are constructed or placed. The California Schools and Local Communities Funding Act, Amendment no. 17-055 (2018). (Note the 19-0008 version of the initiative omits “zoned as” from the definition.)
 While the measure would change the permissible grounds for reassessment, it does not directly purport to change the calculation of property tax liability or the intra-reassessment increases of a property’s assessed value. A plausible reading of the of the draft language does, however, suggest that the initiative may weaken the established 2%/CPI cap on annual increases in assessed value. See id., Section 6 (“[T]he ‘full cash value’ of commercial and industrial real property that is not zoned for commercial agricultural production or otherwise exempt under the [California] Constitution is the fair market value of the property as of that date . . . .”) (emphasis added); See also, The California Schools and Local Communities Funding Act, Amendment no. 19-0008 (2019) (“[T]he ‘full cash value’ of commercial and industrial real property that is otherwise exempt under the [California] Constitution is the fair market value of the property as of that date as determined by the county assessor of the county in which such real property is located . . . .”) (emphasis added).
 According to The Business Journal, before the enactment of Prop 13, some properties were subject to reassessments of 50-100% in a single year. Frank Lopez, Prop 13 Changes Worry Property Owners, Assessor, The Business Journal, February 13, 2020.
 Many People are Moving from California to Texas, The Economist, June 20, 2019.
 Id.; Kay Bell, State Taxes: California, Bankrate, February 18, 2019, https://www.bankrate.com/finance/taxes/state-taxes-california.aspx.
 Jared Walczak, 2020 State Business Tax Climate Index, Tax Foundation, October 22, 2019, https://taxfoundation.org/publications/state-business-tax-climate-index/.
 See Many People are Moving from California to Texas, supra.
 Roland Li, Charles Schwab to Give Up SF Headquarters in $26 Billion TD Ameritrade Deal, San Francisco Chronicle, November 25, 2019.
 The Associated Press, Had Enough? Californians Turn Down Higher Taxes, Debt, The New York Times, March 11, 2020.
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Christopher R. Barry is an associate at Gibbs Giden. He focuses his practice on real estate transactions, including purchase, sale, financing and commercial lease transactions. Mr. Barry also has experience in a variety of corporate matters including mergers and acquisitions, corporate governance and entity formation. Before pursuing law, Mr. Barry worked in the financial services industry, most recently for a global investment bank.