How to Fix the Prop 13 Loophole Without Harming CA Businesses

As of late, much has been written about Proposition 13—the 1978 ballot initiative that keeps property taxes low for landowners, whether they be residential homeowners or commercial landlords.   Under Proposition 13, real property is only to be reassessed when there is a “change of ownership”.  For residential homeowners, the rule is relatively simple to apply—if you sell or transfer your home, the property will likely be reassessed.  However, when property is owned by a business, the rules become extremely complex and contain a gaping loophole.     

This loophole recently gained widespread attention when computer billionaire Michael Dell restructured the purchase of the Fairmont Miramar hotel to avoid triggering a reassessment of the property—a move which saved him an estimated $1 million a year in property taxes.  His strategy involved buying the business that owned the hotel in such a manner so as to ensure that no single person or entity held more than a 50% interest in the business. And so, effectively, Michael Dell, Dell’s wife, and another entity took ownership in the entity, but none of them acquired more than a 50% stake.   This maneuver brought justified outrage—not only from the left, but even the head of the Howard Jarvis Taxpayer Association—the very group that helped ensure Proposition 13’s original passage said that Dell was “gaming the system”.    

 

Unfortunately, many long-time Proposition 13 critics are using this extreme circumstance to attempt to repeal, or effectively gut, the protections afforded by Proposition 13.  The most common “fix” offered by proponents is to only apply the generous rules of Proposition 13 to residential properties and to carve-out commercial properties, allowing commercial properties to be reassessed each year (a position apparently supported by most of the State's editorial board). 

While this approach may seem tempting to those who yearn for higher tax revenues, when one takes into account that California already has the highest income tax, the highest sales tax, the highest gasoline tax and one of the highest corporate taxes in the Nation, it is apparent that California’s budgetary ills are not wholly attributable to “low” revenues.    

Recently, Assemblyman Tom Ammiano (D-San Francisco) introduced a bill (AB 188) that sought to close the loophole and would require a reassessment if 100% of a business were sold or transferred within three years.   While this bill is a good start, the fatal flaw of this bill, however, is that it can easily be planned around (e.g., one can structure the business sale to take just over three years or acquire up to 99.9% of the business ownership without triggering reassessment).    

 There is, however, a way that the Proposition 13 loophole can be permanently closed so that the tax rules are applied fairly across the board while at the same time ensuring that businesses are not hit with increasing property taxes as property values increase.    

This can be accomplished by amending the applicable statutes to provide that when an original owner or owners of a property transfers, either in a single instance or cumulatively, more than 50% of his or her or their business, then all real property owned by that business will be reassessed.  From that point forward, those owners will then be considered the original owners and whenever more than 50% of the business interests are again transferred there will be another reassessment. 

Believe it or not, this “original owner” rule already exists in the Proposition 13 implementing statutes, but for some reason, it only applies if the property was originally transferred to the business by the owners (essentially as a capital contribution).  Thus, if a business buys the real property from a third party, then the “original owner” rule, as currently written does not apply (which is why it did not apply in the Dell transaction).  Thus, by slightly altering the existing “original owner” rule to capture all cumulative transfers of more than 50% of a business’s interests, it will ensure that businesses are given a break on property taxes and also ensure that reassessments do happen when it is clear there has been a change in a business’s ownership.  This slight change is something that the most ardent supporters and opponents of Proposition 13 should be able to agree on.