The Split-Roll Initiative Is Poised to Rock California’s Property Tax System

Current Law
Proposition 13 applies to commercial and industrial properties in the same manner as residential properties.

Under Proposition 13, property is reassessed to its fair market value only when there is a change in ownership or new construction event. Otherwise, property tax assessments may increase by no more than 2% per year and the base tax rate is limited to 1%. 

Proposed Law
Initiative No. 19-0008 (The California Schools and Local Communities Funding Act of 2020) seeks to create what is known as a “split roll” whereby taxable commercial and industrial properties would be stripped of their Proposition 13 protection against reassessment while residential properties would remain protected. The Initiative would leave intact the 1% base tax rate.

Commercial and industrial real properties would be reassessed to their fair market value beginning as early as the 2022-23 lien date and would be required to be reassessed at least every three years thereafter.

Commercial and industrial real property would be defined to include:

• Real property used as commercial or industrial property; or
• Vacant land not zoned for residential use and not used for commercial agricultural production.

Commercial and industrial real property would not include the following property types, which would remain Proposition 13 protected:

• Real property used as residential property, whether owner-occupied or rented, with limited commercial use permitted such as home offices, home-based businesses, or short-term rentals;
• The portion of mixed-use real property used as residential property;
• Land used for producing commercial agricultural commodities; and
• Vacant land used or protected for open space, a park or equivalent designation.

Commercial and industrial real property with a fair market value of less than $3 million would be excluded from the split-roll regime so long as a timely claim is filed annually with the county assessor and none of the property’s direct or indirect owners hold interests in California commercial or industrial real property that, in the aggregate statewide, exceeds $3 million in fair market value. Administering the $3 million exemption would require county assessors to coordinate their value determinations for taxpayers holding property in more than one county. The county assessor’s individual fair market value determinations would be conclusive for purposes of this exclusion and may only be challenged in court for abuse of discretion.

While taxpayers would be permitted to administratively appeal their reassessments, the Initiative provides for much stricter hearing rules by:

• placing the burden of proof on the taxpayer to demonstrate that their property was not properly valued;
• requiring taxpayers to include supporting evidence as part of their initial appeal filing; and
• eliminating automatic acceptance of the taxpayer’s opinion of value if the appeal is not decided within a given timeframe.

The Initiative also contains an unrelated property tax exemption for tangible personal property owned by qualifying small businesses and a combined $500,000 exemption for tangible personal property and fixtures for all other owners.

The Battle Lines Are Drawn
Proponents of the Initiative cite the need for increased school and local community funding as the driving force behind their proposal. Supporters argue that businesses have been unfairly benefitting from Proposition 13 to avoid property tax increases. They estimate that the Initiative would result in a $7.5 billion to $12 billion annual increase in property tax revenue.

Opponents question whether substantially increasing property taxes amid the economic devastation of the pandemic is in the best interest of California, which already ranked nearly last (48th out of 50) in the 2020 State Business Tax Climate Index. Many businesses have already relocated to other states in response to California’s taxation burdens and opponents worry that increasing property taxes will cause additional companies to leave the State. Opponents argue that the stability provided by Proposition 13’s assurance that a property’s assessment will not increase by more than 2% a year plays a vital role in the sustainability of California businesses. The loss of this assurance would increase the burden on small businesses, impact jobs, deter future growth, and ultimately, increase the cost of living in California as much of the additional property tax is expected to be passed on to consumers.

Implementation Challenges
Santa Clara County Assessor Larry Stone told State Assembly members at an informational hearing on June 4th that “[i]t would be impossible—not difficult, but impossible—to administer all of the provisions of the measure as it is written.”

The California Assessors’ Association released a white paper indicating that in order to implement the Initiative:

• the statewide cost to close the assessment roll would increase by $380 million to $470 million annually in the first five to ten years, which includes neither the cost of the technological upgrades that would be required nor the costs associated with the increased workload on downstream agencies;
• 900 new positions would be needed statewide, which is expected to “overwhelm the system” and “take years for counties to fill;” and
• “the number and complexity of appeals submitted will likely result in a major backlog requiring multiple years to resolve.”

Under the Initiative, the additional property tax revenue would go first to cover counties’ increased administrative costs required to implement the Initiative and also to backfill the loss in state income taxes due to the increased deductions caused by the property tax assessment increases. The remaining revenue would then be allocated, county by county, in the same way as current property tax revenues—roughly 60% to local government and 40% to schools.

The Fallout
Small businesses and renters will likely be hit the worst by the Initiative as most are triple net tenants, meaning the landlord will simply pass on the increased property tax to the tenant. The Initiative does not include any reassessment protections for small businesses who rent.

Reassessment is deferred until the 2025-26 lien date for properties that are at least 50% occupied by independently owned and operated small businesses that own California real property and have less than 50 annual full-time employees. However, limiting qualifying small businesses to those who own California realty again overlooks the fact that most small businesses rent rather than own.

The narrow carveout for “real property used for commercial agricultural production” only extends to the land, leaving agricultural improvements such as barns, dairies, wineries, processing plants, vineyards and orchards subject to reassessment.

Property currently shielded from assessment through a new construction exclusion, such as active solar energy systems and work related to seismic retrofitting, life safety and ADA compliance, will become subject to assessment under the Initiative. Recognizing that loss of the property tax exclusion threatens to upend the economic viability of many of California’s solar projects, new legislation (AB 105) has been introduced in an effort to rescue eligible solar projects from the fallout of the Initiative.

Conclusion
The Initiative leaves many things to question, but one thing is clear—if passed, California’s property tax system will be changed drastically. The Initiative needs only a simple majority to pass.