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BPM’s John Hayashi Discusses Proposed CA Property Tax in Law360

05.01.20

John HayashiThis article originally appeared on April 30, 2020 in Law360.

Law360 (April 29, 2020, 7:58 PM EDT) -- Supporters of a hotly debated California ballot measure that would change how commercial and industrial property is taxed have submitted a reworked proposal exempting small businesses to the secretary of state, but the changes are failing to assuage the opposition.

A revamped version of the initiative, known as the California Schools and Local Communities Funding Act, would remove commercial and industrial properties from the protection of California's Proposition 13. It has been submitted to Secretary of State Alex Padilla for signature verification to be on the November ballot and with new language exempting certain small businesses from the proposed change.

Under the revamped initiative, businesses with less than $3 million in real estate holdings in California would be exempt from the plan to change how their property is assessed and taxed from one based on purchase price to one based on fair market value. The new version would also exempt businesses with 50 or fewer employees that own real estate in California, and allow more time to phase in the fair market value taxation by beginning the change on Jan. 1, 2022, instead of making it retroactive to Jan. 1 of this year.

Those changes were designed to protect small businesses and make the plan, which supporters say would yield up to $12 billion for public schools and community colleges in California, easier to administer. But it hasn't changed the minds of opponents and skeptics, who include commercial and industrial property owners, tax and real estate lawyers and county assessors.

"We are all concerned. It's a sea change in investment real estate," said Warren Kessler, a tax partner at Greenberg Glusker Fields Claman & Machtinger LLP who specializes in complicated real estate transactions and who represents large real estate portfolio owners. "This is a really hot topic for my client base in California. This is not some obscure thing."

If, as seems likely, the Secretary of State ratifies enough signatures to place the proposal on the November ballot, voters would have the opportunity to remove commercial and industrial properties from the restrictions of Proposition 13. Prop. 13, as the 42-year-old law is known, requires that purchase price is used to assess and tax all residential, commercial and industrial properties, and limits that tax to 1% of the purchase price with minimal annual adjustments for inflation.

Removing the Prop. 13 assessment restrictions for commercial and industrial properties, known as a split roll system, is expected to yield far higher property taxes for those properties, noted Tim Gustafson of Eversheds Sutherland.

"I'm optimistic that voters will defeat the initiative once they understand how a massive property tax increase like this would affect them both directly and indirectly," Gustafson said.

Moreover, the exemptions for small businesses will lead to disputes about which properties qualify, Kessler told Law360. And those exemptions may not work as intended, because they also will lead immediately to planning opportunities, Kessler said.

For example, he said, a client might have multiple limited liability companies and each might have real estate holdings under $3 million, but if aggregated, the holdings would total more than $3 million.

"Are they related? I can assure you we will be looking at the related standards to see if we can un-relate people," Kessler said.

Similarly, a company may have more than 50 employees in multiple locations, Kessler said.

"Do we break that up into multiple businesses, to come up with ways so that there are 50 or fewer employees? It may be difficult to do, but we will certainly take a look at it," he said. "Those are the kinds of things we will be looking at."

The revised initiative was submitted to the California secretary of state in early April. To be placed on the ballot, it needs 997,139 valid signatures, and the coalition of groups supporting it, known as Schools and Communities First, submitted more than 1.7 million. Sam Mahood, a spokesman for Padilla, said California counties have until May 29 to ratify a random sample of signatures. If the initiative, which has received more than $13 million in contributions from individuals and organizations, is placed before voters, it could pass with a simple majority.

Alex Stack, a spokesman for Schools and Communities First, said the group is optimistic that it can achieve a first — getting a partial Prop. 13 repeal before the voters. He said that in addition to the small business real estate and employee exemptions, the revised proposal includes a tax exemption of $500,000 for the tangible personal property of all businesses and for all the property used by some small businesses.

"We did the refile because essentially you want to strengthen protections for small businesses," Stack said.

That will likely be a selling point for the initiative, noted John Hayashi of BPM.

"In this case, they'll say, we are increasing the taxes for the big businesses," Hayashi said. "And you're [as a small business] going to get a tax benefit because we're going to reduce your business tangible personal property tax and equipment expenditures for your business by exempting the first $500,000."

Other practitioners expressed concern about due process for their clients in the future should the initiative pass. Peter Kanter of Reed Smith LLP said assessors are likely to be so overwhelmed between changes in property tax brought on by the switch to fair market value, in addition to changes created by the downturn amid the novel coronavirus pandemic, that receiving a proper appeal may prove difficult.

Kanter is correct, Larry Stone, assessor for Santa Clara County, told Law360. The 58 county assessors in California are simply not equipped to handle the change in taxation, and the revised proposal doesn't address that, Stone said. Stone, who also chairs the subcommittee on the topic for the California Assessors' Association, said his office typically handles 3,000 to 3,500 assessment appeals each year. But he has estimated that in the first year of a switch to assessment on fair market value, so many property owners would seek appeals that the office would be faced with 25,000 appeals.

"It would be impossible, underscore impossible, for assessors to come anywhere near handling 25,000 assessment appeals," Stone said.

He said he would have to double his staff, which he also termed an impossible task.

Stone said he was against Prop. 13 from the start and continues to be. But he said he understands why the measure continues to be so popular, and makes the point in speeches he gives to school boards and city officials.

"It created predictability in an unpredictable system," Stone said. "The split roll ballot measure is seriously flawed and would create chaos."