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San Francisco Business Times: End commercial property’s free ride

Originally printed in the San Francisco Business Times

By John Stewart

These are halcyon days for California’s budget. As if by magic, in a scant four years, we segued from a $22 billion deficit to an estimated $5 billion surplus.

What went right? Basically, two things. The economy boomed and Prop. 30 temporarily increased both sales and income taxes. But we know what booms do. The sales tax increase expires next year; the income tax portion will sunset in 2018. Then what? Our infrastructure will still be unattended and the homeless will still be with us. Inevitably, there’ll be a search for the guilty and punishment of the innocent as we seek replacement funding

One such is already hiding in plain sight: Prop. 13, but only as it applies to commercial property.

When voters approved Prop. 13 in 1978, the state’s entire property tax system went from one of annual assessment at market value to one based on acquisition price, at a maximum tax rate of 1 percent, and tax increases limited to 2 percent per year. There were downsides to this, but one of the pluses was that homebuyers would finally have the ability to predict their tax burden. Owners would no longer be at risk of having to sell their home if its assessed value skyrocketed but their income did not (think about your parents). Market value was determined by what a willing buyer and seller would pay. A step-up in basis would occur only when there was a recorded deed conveyance. For residential properties, all this was an intended consequence.

Prop. 13 ‘s great benefit to owners of commercial property was not so expected. The original pitch to the voters did not predict that corporations who own shopping centers and office buildings would get a free pass when it comes to sharing the tax burden. But they have. The legislation originally envisioned that two-thirds of the revenue generated would be from commercial rather than residential property. In fact, it’s the other way around.

Why? In the mother of all egregious loopholes, commercial property sales can be structured so that a new owning entity keeps its share to less than 50 percent, avoiding any reassessment. All sorts of legerdemain can occur when a corporation or LLC buys stock in a shopping center that keeps the same name and title without a transfer of the deed of trust. What’s in fact a change of ownership is invisible for tax purposes.

What does this cost? In a recent comprehensive study at the University of Southern California, the authors estimate that if all commercial property was assessed at market value annually, revenue to cities, counties and schools in 2019-2020 would range between $8.2 billion and $10.2 billion. A split roll, one for residential, and one for commercial could, for example, build and operate shelter for all of the state’s homeless. State Senators Loni Hancock and Holly Mitchell have just introduced legislation (SCA 5) which would lead to a state initiative instituting a split roll. This bill will be opposed vigorously by Prop. 13 author Howard Jarvis’ anti-tax acolytes—even though the measure was never intended to effectively exempt commercial property from tax increases.

Perhaps if the issue becomes a ballot initiative, voters will discover they’re being euchred: While they pay their taxes, others with access to high-paid legal and accounting help manage to avoid them. Computer magnate Michael Dell and his family recently bought the Fairmont Miramar Hotel in Los Angeles—but since no one family member owns a majority stake, the 1999 assessment stays in place, saving them $1.1 million yearly.

The more light that shines on this free ride for the benefit of a few and at the expense of many (that’s you), the more likely that we return to what Prop. 13 originally proposed. This travesty should end.

 

John Stewart is a San Francisco-based developer of affordable housing.

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