California’s Prop 15 and What it Means for Commercial Real Estate Owners

A game-changing ballot amendment in California, known as Proposition 15, will go before voters in November. As a result, California commercial property owners may face significant changes to their property bills if voters approve the new measure. If passed, the proposal would remove some tax protections and limitations for commercial and industrial property owners and overall reform the state's landmark yet controversial property tax laws.

 
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The purpose behind the measure is to raise tax funds for state services. Advocates say that money would go to cash-strapped public schools, community colleges, housing, and public safety and local governments. On the other end, opponents say it would hurt small businesses who are already struggling to survive in California, especially during the current economic crisis triggered by the COVID-19 pandemic. This bill may also hurt farmers who would be subjected to higher taxes on processing facilities and grocery stores if the bill is passed. Additionally, opponents emphasize that many small businesses do not own their buildings/office space, but the standard commercial lease agreements require them to pay for maintenance and property taxes.

What is Prop 15?

Substantially, Prop 15 would amend part of the 1978 ballot initiative that fundamentally changed how California taxes property. Approved by voters in 1978, Proposition 15 was a trademark victory for California conservatives and anti-tax activists. Since its passage, Prop. 15 has capped property tax increases at 2% each year form homes, businesses, and farmland. Properties are then reevaluated when they are sold at 1% of the sale price. The end result is that properties on the same street often have very different tax values assigned to them. Furthermore, in states like California where property appreciates quickly, this tax system frequently leads to situations where properties are assessed at only a portion of their actual market value, which arguably deprives local government and school districts of much-needed additional income.

The new plan would separate the tax roll of commercial and industrial properties from residential properties and reassess these properties at least every three years at their actual market value. Arguably, the current law has made it challenging for local governments and school districts to pay for services since a majority of their revenue comes from property taxes. However, by raising taxes on commercial and industrial properties, the proposed amendment to Prop 15 would generate somewhere between 6.5 to 12 billion per year in additional income. The proposal does not affect residential homeowners' property tax bills.

Are there any Exemptions under Prop 15?

The Prop 15 amendment does not apply to Single-family homes, multifamily complexes, standalone businesses, and agricultural land, and owners of commercial or industrial property that has a combined value of $3 million or less. For purposes of the $3 million or less exemption, the fair market value of a property is combined with the fair market value of all other commercial properties in the state in which any owner owns a direct or indirect beneficial ownership interest. If the combined sum of all such properties exceeds $3 million (with eligible adjustments), the exemption no longer applies. An owner is defined as any direct or indirect beneficial owner.

How will Prop 15 affect commercial real estate owners?

In short, commercial real estate owners should prepare for higher tax bills, if Prop 15 is passed. Under the controversial Prop 15, commercial and industrial properties, as well as land, will be reassessed for property tax based on the market value at least every three years.

Essentially, the proposed amendment creates a "split-roll tax system," splitting the residential and commercial property tax roll.

Nuances For Mixed Used Properties

For properties that include residential and commercial units, (i.e., mixed-use properties), only the portion of the building that is used for commercial purposes will be subject to the new tax scheme. Mixed-use property will be apportioned between the residential and commercial tax rolls on a proportionate basis. The latest version of the bill states that mixed-use properties would retain their full Proposition 15 status if it is at least 75% of the building is used for residential purposes.

What do commercial real estate owners need to know before the election?

Commercial real estate owners must be prepared for the possibility that their taxes will increase substantially if Proposition 15 is passed. In any event, advocates will inevitably face a challenge passing the amendment as concerns over the COVID-19 pandemic continues to rise. Overall, it is unclear whether voters will embrace sweeping tax changes in the middle of a pandemic and recession.

To learn more about Prop 15 and what impact it may have on your property, feel free to give me a call at 858-458-3361 or email me at ajize@voitco.com.

Alex Jize