How Will New Tax-Related Measures Play Out?

SAN FRANCISCO—Most of the tax-related ballot measures for the state and city passed in the last election, with the exception of Proposition 15. Recently, Allen Matkins partner Bill Ahern, associate Anosh Ali and associate Jared Kassan shared some insights into what the rejection and passage of these measures mean for commercial real estate at the local and state level.

GlobeSt.com: California voters were asked to consider a number of different tax-related state and local ballot measures. What proposition was the most contentious?

Kassan: Proposition 15 was the hardest fought campaign, which was narrowly rejected by voters. It asked voters whether to change, solely with respect to commercial and industrial property, longstanding property tax rules that generally limit a county’s ability to tax real property based on its acquisition value plus an inflation factor.

Proposition 15 was an attempt to create a split roll. Under the proposed split roll, commercial and industrial property with a fair market value in excess of $3 million would be reassessed at its current fair market value at least every three years. For commercial and industrial property that had not undergone a change in ownership for a long period of time, it likely would have had the effect of increasing the property tax burden significantly for those owners. In an attempt to garner the support needed, Proposition 15 excluded both residential (single-family and multifamily) and agricultural property, and such property would have remained subject to the same property tax rules that have been in place for over 40 years.

GlobeSt.com: What happens now with the failure of Proposition 15?

Kassan: For now, all real property in California will remain subject to the current property tax regime, which generally provides that real property is taxed at a percentage of its assessed value. Unless a property undergoes a change of ownership or there is new construction on the property, the property’s assessed value equals the property’s base value, i.e., the property’s value at the time of purchase, plus an inflation factor that cannot exceed 2% per year. The general tax rate is 1%, but the rate can increase above 1% to pay for voter-approved indebtedness and in most counties in California, the rate is slightly higher than 1%. Under the current property tax regime, a property’s base value can be significantly lower than its current fair market value, which in turn can reduce the amount of property tax that might otherwise be owed if a property was assessed at its fair market value, but the current regime provides the owner with certainty as to what the owner’s expected tax liability will be with respect to the ownership of such property.

Because of the way the current property tax regime was created in California, any significant changes must be approved by a majority of California voters, so any future attempt to change the current regime would need to be through a future ballot initiative similar to what Proposition 15 tried to accomplish.

GlobeSt.com: What other tax-related statewide measures were on the ballot and what implications will they have?

Ahern: California voted on and approved Proposition 19, a complex property tax initiative that provides certain increased property tax benefits to certain California residents when they move their primary residences, and reduces certain property tax benefits for certain intergenerational real property transfers.

Under these property tax rules, when property changes ownership, it is reassessed and the property’s base value is reset to its then-current fair market value. Current California law provides that the transfer of a principal residence from a parent to child (and in certain cases, from a grandparent to grandchild), may be exempt from reassessment regardless of the current fair market value of the property and whether the transferred property is subsequently used by the child as the child’s principal residence or for some other purpose such as a rental property. Additionally, current law provides that the first $1 million of the assessed value (not market value) of any property that is not the parent’s principal residence (vacation homes and rental/investment properties) may be transferred from parent to child without triggering a property tax reassessment. Those exemptions are generally referred to collectively as the parent/child exemption.

Proposition 19 severely limits the ability to use the parent/child exemption. More specifically, Proposition 19 provides that the parent/child exemption will be limited to transfers of a principal residence provided that the child uses the transferred property as his or her principal residence and the difference between the assessed value and current market value of the transferred property does not exceed $1 million. If it does exceed $1 million, a partial reassessment will be triggered. Additionally, the ability to transfer an additional $1 million of assessed value without causing a reassessment will be eliminated. Voters narrowly approved Proposition 19 and the updates to the parent/child exemption will apply to transfers made on or after February 16, 2021.

Proposition 19 also increases certain property tax benefits. It provides that homeowners over the age of 55, those who have severe disabilities or those who are victims of natural disasters may transfer the property tax-assessed value of their principal residence to a different primary residence anywhere in the state, up to three times. If the new primary residence is more valuable than the prior primary residence, the assessed value only increases by that difference. This will be a change from current law, which provides that such individuals may transfer their assessed value only if the replacement home is of equal or lesser value and located in the same county or in a county that accepts inter-county transfers, and may do so only once. These updated provisions will apply to transfers made on or after April 1, 2021.

GlobeSt.com: San Francisco voters approved multiple tax-related ballot measures. What effect will this have on businesses?

Ali: The approval of certain tax-related ballot measures in San Francisco will have the effect of increasing the overall tax burden on businesses within the city through higher taxes on real property transfers, higher gross receipts taxes and a creative new tax aimed at executive compensation. The increased transfer tax and updated gross receipts tax will become operative on January 1, 2021. The new tax aimed at executive compensation will go into effect for tax years beginning on or after January 1, 2022.

GlobeSt.com: What are the details of these three approved San Francisco ballot measures?

Ali: Proposition I doubles the transfer tax imposed on transfers of real property located in San Francisco in excess of $10 million. Specifically, the transfer tax rates will be increased from 2.75 to 5.5% for transfers of properties located in San Francisco with fair market values between $10 million and $25 million, and from 3 to 6% for transfers of properties with a fair market value of $25 million or greater. The events that trigger transfer tax remain unchanged, and a sale, even with a loss, will trigger a significant transfer tax liability.

Proposition F is an overhaul of San Francisco’s business tax regime and primarily will significantly increase tax rates of the existing gross receipts tax imposed by the city, repeal the payroll expense tax imposed by the city, reduce the annual business registration fee for businesses with $1 million or less in gross receipts attributable to the city, increase the small business exemption ceiling for the gross receipts tax to $2 million, and increase the annual business registration fee on businesses benefiting from the forgoing increased exemption ceiling (businesses with gross receipts between $1 million and $2 million). Because of ongoing litigation regarding the validity of Proposition C passed in 2018, which created additional gross receipts for large businesses as well as gross receipts on commercial rents, Proposition F also contains a backstop to reinstate those taxes created by Proposition C if the existing litigation were to invalidate Proposition C.

Proposition L will impose an additional gross receipts tax on each person engaging in business within San Francisco if the executive pay ratio for the tax year of the person (or combined group) exceeds 100:1. The term executive pay ratio means the ratio of the annual compensation paid to a person’s (or combined group’s) highest-paid managerial employee for a tax year and the median compensation paid to a person’s (or combined group’s) employees based within the city for that tax year. The highest-paid managerial employee need not be based within San Francisco. Compensation is a broad term that encompasses wages, commissions, bonuses and property issued in exchange for services and specifically includes compensation for services paid to owners of pass-through entities.

The tax imposed by Proposition L is not limited to large or publicly traded companies and because the tax is imposed on gross receipts as opposed to profits, even businesses generating a loss may incur significant tax liability. The tax rate imposed by Proposition L will range from 0.1 to 0.6% on a business or combined group’s taxable gross receipts attributable to the city for executive pay ratios ranging from 100:1 to 600:1. In the event a person engages in business in San Francisco as an administrative office, the tax rate imposed will range from 0.4 to 2.4% of the person or combined group’s total payroll expense attributable to San Francisco for executive pay ratios ranging from 100:1 to 600:1.