Gradually Increase Commercial Property Tax rates to Market is A GOOD IDEA

Field polls about Prop 13 is like asking people if they would like to see their property taxes increased.  How many individuals own commercial property?  Most Californians know that Proposition 13 protects residences from sudden changes in property taxes, except when the residence changes hands. Proposition 13 is a ballot measure passed by the people of California in 1978 backdated to 1975.  Few Californians realize, however, and need to learn that Proposition 13 applied to all real property, including commercial, industrial, and rental real estate.

The results have not been good for California, nor even for homeowners as a group.  Single family residences change hands on the average once every five to ten years, and every time they do, their property tax assessment is updated to fair market value.  While some homeowners, especially elderly ones, have been in their homes for decades, the property tax assessments on the bulk of existing homes lag fair market values by less than ten years.  They are locked into their homes for a very long time.  New homes, of course, are immediately assessed at fair market value.

On the other hand, apartment houses and commercial and industrial property are usually held by companies or partnerships, and they change hands far less often.  If the property is not actually sold or transferred, there are two rules governing when a reassessment will occur for real estate which continues to be held by the same partnership, or company.  For properties that were owned by the entity at the time Proposition 13 was passed, reassessment will only occur if there is a change in the control of the entity owning it.  The change in control is defined as a single individual, or another entity, acquiring more than 50% of the ownership.  Therefore, for entities existing at the time when Proposition 13 was passed, reassessment of their real estate can essentially be avoided forever, by the expedient of making sure that no one person or company or partnership gains control.  Homeowners should be angry about the huge inequity.  For large, publicly-held companies (e.g., PG&E), it is virtually impossible, in the absence of a merger or takeover, that anyone will obtain 50% ownership.  For closely-held entities such as family partnerships or family corporations, that existed at the time of passage of Proposition 13, careful planning can usually make sure that ownership continues to be sufficiently dispersed among family members so that no one individual acquires 50% control.

For entities formed after the passage of Proposition 13, a different and less favorable rule applies. Reassessment of their real property will occur when 50% of the ownership changes hands, regardless of what effect that has on control.  Nevertheless, careful planning can often delay for many decades the time when a cumulative transfer of 50% of the interests has occurred. For example, if parents wish to transfer substantial real estate interests to their children, they can form a partnership, transfer to the partnership a number of properties which may have been sheltered from property tax increases by Proposition 13 for many years, and then transfer 49% of the partnership to their children.  With appropriate estate planning, there will be no reassessment of those properties, and only the limited increases in property tax allowed by Proposition 13, until both parents are deceased.  Another possibility is to transfer significant interests in real estate to children, sheltering the transfers from reassessment by the use of the $1,000,000 parent-to-child exemption.  If the parents and the children then transfer all of their interests into a family partnership or limited liability company, the children may already own 51% of the partnership, in which case there may be no reassessment of the property even after the death of both parents.

Thus, we have a situation where single family residences are reassessed with relative frequency, while apartments and commercial and industrial properties can often avoid reassessments for very long periods of time.

The perverse result has been a gradual but substantial shift of the property tax burden away from commercial and industrial property, and onto residential property.  On the face of it, this appears to be almost the reverse of what the voters presumably thought they were doing when they passed Proposition 13.

James U. Hall is the former president of the Santa Clara County Chartered Life Underwriters Society, General Agents and Managers Association.  John E. Upton was a supervisor of El Dorado County Board of Supervisors from 1990 to 1998, and the former president of the California State Association of Counties.

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