A Split Decision: Property owners wrestle with proposal to changes to tax law

_MG_1668ed-webSAN FRANCISCO—A California proposal to dismantle nearly four decades of protection from commercial and industrial property tax increases puts familiar adversaries back in the ring: anti-taxation business interests and advocates for education and social services funding increases. They are dusting off a fiery debate, focusing on tax burden fairness and whether business should foot more of the bill to salvage an educational system in decline. Meanwhile, both sides circle a potential annual bounty of $9 billion.

“If you take $9 billion out of the economy, that’s lot of money not invested,” said Rex S. Hime, president and CEO of the California Business Properties Association. The CBPA has joined Californians to Stop Higher Property Taxes, a coalition opposing a new legislative proposal to restructure how businesses property is taxed. Coalition members include the California Apartment Association, California Association of Realtors and the California Chamber of Commerce.

At issue is Senate Constitutional Amendment 5, known as the “Property Tax Fairness Amendment,” or “Split Roll SCA 5,” a bill introduced in June by California Senators Loni Hancock (D-Oakland) and Holly Mitchell (D-Los Angeles) that would keep current tax increase protections in place for residential and agricultural property owners but remove them for other business property owners. It is the latest in a long line of attempts to undo tax protections established by an overwhelming majority of voters in 1978 with the establishment of Proposition 13.

To advocates, the billions collected would not only mean a world of difference to a California school system in decline, but a leveling out of decades of taxation imbalance created by under-assessing business properties. Also addressed would be problematic loopholes in the law identified by both sides.

“Making it fair means closing the commercial property loopholes in Proposition 13 while preserving all of the vital protections for homeowners and renters,” said Bergen Kenny, a spokesman for the Make It Fair campaign, which is made up of more than 260 groups, including the League of Women Voters, Housing California and the San Francisco Board of Supervisors. “This will not impact homeowners or renters at all—except to make the services we use and the communities we live in stronger.”

Amending Proposition 13
Proposition 13, known as the People’s Initiative to Limit Property Taxation, was spearheaded in part by residential property owners who claimed individuals were being taxed out of their own homes at a time of skyrocketing property values. When it passed, property tax values reverted back three years. Annual assessment increases were capped at no more than 2 percent of the inflation rate, until a property is sold again, is newly rebuilt or undergoes a significant renovation.

At issue under the current proposal is how often commercial and industrial properties are assessed for taxation. If SCA5 gains approval from two-thirds of the legislature, gets on the November 2016 ballot and is passed by voters, the state would initiate, starting in 2018, a multi-year phase-in of new property assessments aimed at bringing commercial properties up to their fair market value. Residential and agriculture property owners would be exempt from changes in the new law. Beginning in 2019, businesses would receive an exemption for the first $500,000 in equipment and fixtures subject to business personal property taxes. This exemption would eliminate the tax for more than 90 percent of small businesses whether they rent or own the facilities in which their business operates, according to supporters.

“This legislation will address flaws in Prop. 13 that have allowed a minority group of wealthy corporations and commercial property owners to dramatically lower their tax bills and shift that responsibility onto homeowners and renters,” Hancock said in June.

Proposition 13 may have been created to protect individual property owners, but it has “given a windfall to the corporate owners of commercial property” who don’t need this protection, according to former US Secretary of Labor Robert Reich, who has stepped up as a spokesperson for the Make It Fair campaign. In an online campaign video, Reich says all businesses “in the real economy … are supposed to compete on a level playing field with new companies whose property taxes are based on current market prices.”

In the past 25 years, there have been at least 15 unsuccessful formal proposals for some kind of split roll taxation, according to a state Board of Equalization report. Seven of the proposals were voter initiatives. The one that made it onto the ballot—Proposition 167, which would have modified the change in ownership definitions related to legal entities, was defeated in 1992 by a 3-2 margin. Last year, an attempt to close loopholes that allowed businesses to change hands without triggering the 50% ownership clause failed to get enough support. Detractors claimed it didn’t go far enough; supporters claim it was shut down as a political maneuver to pave the way for this broader legislation.

In June, just days after Senators Hancock and Mitchell announced SCA 5 as the “Property Tax Fairness Amendment,” the San Francisco Board of Supervisors voted unanimously to approve a resolution supporting it. They said commercial property owners have been able to avoid property reassessment by limiting the portion of ownership that changes hands, which has shifted the tax burden away from commercial properties to residential properties—a statement argued by SCA5 detractors.

“In large part because of Proposition 13, California has been forced to rely on volatile revenue sources like income and sales taxes instead of stable property taxes,” the supervisors said. They said it is “anti-competitive” to force new businesses paying fair market value for property to compete against businesses that aren’t subject to similar property tax rates.

SCA5 would generate $692 million for San Francisco County, according to analysts from University of Southern California Program for Environmental and Regional Equity.

In 1978 corporations paid 44 percent of all property taxes. Now, after exploiting this loophole for years, corporations pay only 28 percent of property taxes, according to Make It Fair. Rather than propel businesses to set up corporate headquarters out of state, SCA5 will level the playing field.

Opposing Numbers
Opponents, however, say those numbers are wrong. The proposed law would siphon billions of dollars from the economy, stifle business and cause companies to move their offices to more tax-friendly states. According to a Pepperdine University study in 2012, “An Analysis Of Split Roll Property Tax Issues And Impacts,” a split roll property tax would cost the California economy a total of $71.8 billion in lost output and 396,345 jobs over the first five years, followed by greater losses in later years.

“Because small businesses typically lease properties where the cost of property taxes is passed through to the lessee, this research concludes that the employment losses described above would be disproportionately concentrated in small businesses, and especially those owned by women and minorities,” the Pepperdine report states.

“Protecting Proposition 13 is one of the most important issues for the rental housing industry,” said Debra Carlton of the California Apartment Association. Although residential and agricultural property owners would be exempt under SCA5, many CAA members own commercial or mixed use properties that would be affected, she noted.

San Francisco broker James Wavro predicts such a law would impact leasing rates and cause businesses to reassess their locations.

“What they might gain in property taxes could easily be offset in corporate taxes by companies deciding they don’t want to be in California any longer,” Wavro said.
SCA5 is simply a strategic push to eventually do away with Prop. 13 altogether, according to Andrew Jeffery, cofounder and director of acquisitions at Cirios, a San Francisco-based property investment firm.

“This would be a logical way to phase it in,” he said.

The Cirios portfolio is comprised of about 60% apartment and 30% commercial properties. Founded in 2011, Cirios would probably experience little direct impact from SCA5 because most of its nonresidential property investments are new purchases that have recently been reassessed. It’s the owners of older, small businesses who have incorporated lower property values into their overhead who would be more likely to suffer from increased property taxes, Jeffery said. An auto body shop in a neighborhood with skyrocketing property values would be hit hard. It’s difficult to keep small business tenants in place once a property is sold and costs are passed along, Jeffrey added, noting that even if increases are phased in, it’s unlikely to keep small business property owners in place long-term.

“It’s really just a longer time to relocate,” Jeffery said. “The bigger impact is that you would have a huge amount of people sell their buildings because they don’t want to pay that higher tax. For our business, it would be terrific. It would be a good buying opportunity.”

Perhaps an upside to the small business relocations would be increased development, Jeffery said. “A lot of people who’ve owned commercial buildings for a long time aren’t putting money into them. They aren’t redeveloping them.”

Public Opinion
Most people are familiar with Prop. 13 and have an opinion about it, according to Dean Bonner, an associate survey director with Public Policy Institute of California, which has conducted surveys on the issue of Proposition 13 for years. According to a survey in May, 93 percent of respondents have an opinion about it.
“That tells you a little bit about the issue,” Bonner said. “It’s something that’s being talked about. It’s definitely important to people.”

For the last three years, the PPIC survey has asked Californians about a “split roll” tax on property and whether they approved the idea of taxing commercial properties according to their market value while leaving limits on residential property taxes intact. In May, half of adults and likely voters said they favored the idea. That’s down from 60 percent in favor in 2012.

The PPIC survey question about Proposition 13 doesn’t link split roll taxation to education funding, which could make a difference to voters, according to Bonner.
“We know that people are willing to pay higher taxes for schools,” Bonner said. “We know that when it comes to school financing people are always willing—6 in 10—to pay higher taxes to fund schools.”

That is the crux of the issue for real estate consultant Alan P. Mark, president and founding partner of The Mark Co. in San Francisco.

“Overall we need to improve the educational system in our city and throughout our state,” Mark said. “If some of the funds can be earmarked for that purpose, then we’ve achieved a great goal. That topic is really a third rail. It is great that this idea has come up to bring more funding to the state.”

Is the Future Looking Too Rosy?
But is more funding actually needed? The PPIC survey in May reported that the number of adults who say the budget situation is a big problem is close to a record low. Californians, in particular San Francisco Bay Area residents, increasingly say “things are generally going in the right direction” and they expect good times financially in the next year.

Hime says public concern about the state budget situation has eased in recent years and education funding has improved.

“Right now the state is recovering,” Hime said. “We’ve paid off our state debt and our surplus has gone to education. A lot of people wonder, ‘Why do we need to create new taxes?’ The wiser thing to do is to let the economy have that $9 billion to continue to generate more jobs and economic growth.

We want to make sure our services and schools are funded, but it’s money that would’ve been elsewhere, a lot of it from small businesses. And, ultimately the consumers are going to be paying for it.”

For more information on split roll taxation and SCA 5, visit stophigherpropertytaxes.org and makeitfairca.com.

This article is published in San Francisco Apartment.


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