California: Pending Challenge to Proposition 13

For the past 25 years, California has increased most transaction and income taxes, resulting in the highest rates in the U.S. in all categories but property taxes. As a result, there is another proposal, this time from the SEIU-UHW, which is the United Healthcare Workers West union. So far, they don’t have the California Teachers Association support, who historically is at the front of the proposed changes to Proposition 13 (“Prop. 13”). They are attempting to change Prop. 13 law that dictates how the local assessors arrive at a property value every year. Prop. 13 establishes a base year value for property tax assessments and limits the amount a property’s taxable value can rise every year. Since its enactment in 1978, the voters have been asked to change the original law 33 times.

To gain voters’ approval, opponents of Prop. 13 have historically gone after removing the annual cap increase on commercial real estate; the most recent example of this approach was Proposition 15 (Split Roll), which failed to pass in 2020. In addition to not garnering voter approval, assessors opposed the changes as well. The split roll would require frequent appraisals of commercial real estate and substantially more staff, making it much harder for the assessors to guarantee each year’s contribution of property tax revenue to the county. With Prop. 13 remaining in place, assessors can continue to easily forecast tax revenue, based on steady slow growth.

A new proposition titled “Housing Affordability and Tax Cut of 2022,” is gaining signatures for addition to get on the November 2022 ballot. Unlike the spilt roll, this initiative would not specifically target commercial real estate but rather increase the tax rate to 1.4% on all property types valued more than $4,000,000. For property valued more than $5,000,000, there would be an addition 1.2% surcharge added to the new tax rate, increasing the rate from 1.0 to 2.6%. The old rate has been relatively unchanged for the past four-plus decades. To get voters’ support, the proponents of the initiative would increase the homeowner’s exemption from $7,000 to $200,000, reducing tax bills on properties under $4,000,000. Please note, none of these values are indexed, so as the real estate market increases, more and more properties will fall in these categories. We have detailed the impact below:

The increased revenue will pay for the larger homeowner’s exemption and bigger renter tax credits. The supporters of the initiative also seek to gain support from assessors because the proposition only increases the tax rate and doesn’t require a reassessment of properties unless there is a change of ownership or new construction.

Commercial properties’ largest operating expenses are property taxes, even with the caps implemented by Prop. 13. Also, most commercial property in California is assessed at greater than $4,000,000. This proposal would significantly increase owners’ operating expenses. As expenses increase, owners’ net operating income is reduced, causing the fair market value of their assets to decline. Many property owners live outside California and will not be able to vote but will still be impacted by the tax increase. The local experts at Ryan recommend a full review of the annual assessment because if this proposal passes, property owners may have an appeal position to reduce their property tax liability. Please reach out to us with questions and check back for updates regarding this initiative.

Notes:

When Prop. 13 passed in 1978, it set assessed values back to the 1976 fair market value of the property.  The assessment could only be increased annually by the increase in the state’s consumer price index or 2%, whichever was lower. The only time the assessed value could be increased to market value was if there was a change of ownership or new construction. This allowed homeowners to keep their homes, in times of very high value appreciation. Prop. 13 also established a tax rate of 1%, and the rate could only be increased if it received two-thirds of the voters’ approval. Most of the opposition to Prop. 13 came from those who didn’t like the inequity of the way it levied taxes because the longer you owned the property, the greater the range was between the assessed value and fair market value.

TECHNICAL INFORMATION CONTACT:

Marc Hartley
Principal
Ryan
442.244.2426
marc.hartley@ryan.com

The material presented in this communication is intended to provide general information only and should solely be seen as broad guidance and not directed to the particular facts or circumstances of any individual who may read this publication. No liability is accepted for acts or omissions taken in reliance upon the content of this piece. Before taking (or not taking) any action, readers should seek professional advice specific to their situation from Ryan, LLC or other tax professionals. For additional information about this topic, please contact us at info@ryan.com.