By Andrew Gradman, Esq.

An earlier version of this article was published by California Continuing Education of the Bar (CEB.com) on June 25, 2020

On May 29, 2020, the California Secretary of State announced that the California Schools and Local Communities Act of 2020 qualified for the November ballot.  The measure would create a “split roll” property tax—preserving our current (acquisition value) property tax regime as to agricultural land, residential property, and lower-value commercial and industrial properties, while reverting to the pre-Proposition 13 (ad valorem) tax regime as to higher-value commercial and industrial properties.

Split-roll alternatives are as old as Proposition 13 itself. As soon as Howard Jarvis and Paul Gann qualified their radical measure for the 1978 ballot, the California legislature proposed a competing measure, Proposition 8, which would have permitted owner-occupied residential property to be taxed at a lower rate. Proposition 8 gained the support of almost all top spokesmen for both parties, labor unions, teachers’ associations, the League of Women Voters, and most other groups, but failed anyway. See Sean Flavin, Taxing California Property, § 2:2.  Since then, split-roll measures have continued to pop up periodically.

Proposition 13 set the taxable value of real property to equal the lower of (1) its fair market value on the lien date of the year in question, or (2) an inflation-adjusted base year value which is updated to fair market value only upon change in ownership; new construction; or certain declines in value. Proponents of a split-roll tax argue that current law is a mess of loopholes which favors sophisticated taxpayers, disproportionately burdens unsophisticated residential owners, and deters owners from improving their properties. According to a USC study, more than $11 billion in local property taxes per year go uncollected due to under-assessment. Opponents of a split-roll tax argue that the tax increase would lead to lost economic output, decreased employment, and increased instability for local government finances.

The 2020 measure contains these provisions:

  1. It exempts all residential property, regardless whether owner-occupied.
  2. It exempts all “land that is used for producing commercial agricultural commodities” (though not agricultural structures or improvements—such as barns, dairies, processing plants and wineries, and certain crops and orchards).
  3. It temporarily exempts a property from reassessment if at least 50% is occupied by a small business (i.e., fewer than 50 full-time employees; independently owned and operated; and owns real property located in California).
  4. It exempts “each commercial and industrial real property with a fair market value of [$3,000,000] or less … adjusted for inflation.” However, this exemption becomes unavailable, and “real property that would otherwise comply with [that exclusion] shall be subject to reassessment … if any of the direct or indirect beneficial owners of such real property own a direct or indirect beneficial ownership interest(s) in other commercial and/or industrial real property located in the State, which such real property in the aggregate (including the subject property) has a fair market value in excess of [$3,000,000] … adjusted for inflation.” To enjoy the exemption, the property owner must certify annually to the county assessor under penalty of perjury that the preceding conditions have been satisfied.
  5. It contains several provisions to reduce the burden on the county assessors. New assessments will be phased-in over several years; courts may review factual findings only on a limited standard of review; and new tax revenues will first go to the counties, to reimburse them for their extra administrative costs. These accommodations are important. In March 2019, the California Assessor’s Association wrote that a split-roll measure could cost counties between $380 million and $470 million in the first five to ten years, and that a failure to fund these costs “could have a devastating impact on the operations of California assessors and their ability to deliver quality customer service to taxpayers.” It is unclear whether the 2020 measure adequately addresses these concerns.

If any provision will create confusion, it will be the special rule for direct or indirect owners owning $3,000,000 of property in the aggregate. A few questions come to mind:

  1. How is an owner’s “aggregate property” defined—should it be limited to his interest in each property, or should it include the portions he does not own?
  2. How will joint ventures work? If a single co-owner fails the aggregate property test, will that cause reassessment as to the portions of the subject property owned by the other investors? If so, joint venturers will need to do due diligence on all the “direct and indirect beneficial owners” of the subject property before letting them join the deal.
  3. Who is a “beneficial owner?” Conventionally, the term describes the beneficiary of a trust (see RTC 63.1(c)(9); Property Tax Rule 462.160; Assessor’s Handbook generally), but not the owner of an interest in a business entity. Can we assume that the ballot measure will be interpreted in the same way?
  4. Who is an “indirect beneficial owner?” Is this intended to expand the term to include (say) partners and shareholders?
  5. Trusts present another special problem: In some cases, beneficiaries do not know what assets are in the trust; they may not have the right to know; in fact, they may not even know of the trust’s existence. How will they complete the certification? In marginal cases, the diligence may prove impossible; the certification cannot be signed; and (perhaps) the deal will fall apart.

I don’t mean to suggest that these issues are fatal to the measure. However, if it does pass, the legislature will need to clarify. Here are my proposed answers to these questions:

  1. “Aggregate property” should be limited to the owner’s interest (i.e., his proportional interest, unreduced by minority discounts).
  2. If a single co-owner fails the aggregate property test, that should cause his interest to be reassessed, but not the interests of his co-owners.
  3. “Beneficial ownership” should be limited to title ownership, as well as current beneficiaries who are “beneficial owners” of a trust with title ownership.
  4. “Indirect” beneficial ownership should not be interpreted any differently: It should include trust beneficiaries, but not entity owners.
  5. When trust beneficiaries complete the annual certification, they should be asked to attach a similar certification from the trustees of all trusts whose existence they know of.

One thing is certain:  Get ready for a new wave of loopholes—real and purported—and for a new wave of tax consultants who claim they can hack the aggregate ownership rules. The legislature will have to draft these rules carefully.