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In the late 1970′s an attempt was made to rein in the uncontrolled taxation of real estate property in California. This effort became known as Prop 13. The idea was simple. All real estate would be taxed at a base year rate, and there was an annual limit on how much the tax could increase each year. This allowed people to properly plan and manage their real estate taxes and ended a process where people would be surprised by massive increases in property tax from reassessment.
And all was good.
But there was also a series of decisions that were made that would trigger a reassessment of real estate property. If a property was sold, then the sale would establish a new base rate for the property for future taxation. And if the property was altered (for instance more square footage was added to the property) this too could trigger a reassessment for the property.
And all was good.
Well, not really.
See, there are different types of real estate. There is the real estate of a single-family residence or the home or condo where one lives, and then there is the real estate that is income-producing. Income-producing real estate is generally commercial in nature. A hotel, a strip mall, a multi-family apartment complex, a warehouse, an office building, a restaurant.
When was the last time that you saw someone add a 21st story to a 20 story office tower? Add another 20,000 square foot to an existing 50,000 square foot warehouse? Tear down the walls of an existing grocery store to add 15,000 square feet?
On the other hand we all know one person who owns a home on a street where they or one of their neighbors made modifications to their home and triggered a reassessment of their real estate.
So we have defined two separate classes of real estate. One will almost never be affected by reassessment and the other will.
These two classes have something else in common. In most cases that single family home is in an individual’s name. And that commercial property? In most cases the ownership resides in a corporate entity. When a person sells his home, it’s generally sold as a transaction between two individuals (sometimes listed a a man and wife selling a real property to another man and wife, but in most cases between individuals.)
But different story with those commercial properties. In fact a change of real ownership can occur, with the listed real property owner not changing. For example, CompanyA, LLC owns a 20-story office building and, instead of selling the real property, all the stock in CompanyA, LLC is sold from CorporationZ to CorporationX. So CompanyA, LLC stills effectively owns the real estate, as the real estate actually was sold or transferred from one owner to another.
When there’s a change of ownership in that single family residence, that triggers a reassessment of the property’s valuation and taxation, but the change in ownership of the real estate between the two corporate entities through the change in ownership of the LLC does not.
Why is this all important? Because these two specific loopholes have changed the tax burden in every county in California. Individuals who own their primary residence have, year after year, been paying a larger share of the property taxes received by the State of California, while at the same time the amount of property tax received has been declining as these commercial properties are not being reassessed.
Within tax policy circles this actually has a name, it’s called a split-roll. And one of the key things that a split-roll does is shift the tax burden over time away from one side of the split and to the other side of the split.
Now let’s look at two properties. The first is a single-family residence and the second is a four-story office building. Both properties were built prior to Prop 13. In the almost 35 years that Prop 13 has been in effect there have been no additional feet added to the four-story office building, and the LLC that has owned it, although having been sold three times, still owns the real estate. In all those years, the property has not be reassessed. The single-family residence on the other hand has been sold three times in that same time period, and at least two of the owners have made additions to the property. So that property has been through at least five reassessments.
Now anyone can tell you that this is clearly “not fair.” And that’s the primary cause in the tax-burden shift that’s pushing a greater burden of property taxes from commercial property owners to those that own their homes. In simple terms it’s costing the State and the Counties billions of lost revenue, an at the same time rewarding those commercial property owners and punishing folks who live in their homes. Something tells me that was not what the people that voted for Prop 13 were intending to do to themselves.
Now, let’s look at some other things that are happening at the same time. Since the income is going down for the State and the Counties because these commercial properties are not being reassessed the State and the Counties, in fact all of government, has had two choices. It’s either had to find creative ways to increase revenue, or find ways to cut what they spend. So parks that were generally free to access in the late 1970′s and 1980′s now have entrance fees. The fees for licenses and registrations have risen. The cost for attending college or university has risen. In other words, rather than sharing the pain for these items of common good there has been a shift of the burden to those that use these common services. And when the costs could not be covered by new fees for service, the services have been cut. A high school arts program here and a music program there, and suddenly California went from having the best public schools in the nation to being much further down the list.
But this is a shared pain for us, we all suffer equally, right? Not quite. Let’s look at an example of two commercial buildings side-by-side in downtown LA. The first is a 10-story office building built pre-Prop 13 and the second is a 10-story office building erected in 2010. As you’d expect, the older building has a much lower property tax based on the early assessment and the capped increases of Prop 13. So, one would assume that the rent per square foot charged in these two buildings would reflect the fact that the renters in the older building are paying a much lower rate. But that’s the problem with assumptions. Both building are well within the going rate for square footage in that area – the older building may have a slightly lower rate, but it’s well within the same range.
If that’s the case, then the owner of the first building, with substantially lower overhead costs brought about by the fact that his property taxes are set so low by the Prop 13-protected assessment, is clearly making a much greater profit margin due to his lower overhead costs and comparable rental rates. In other words, not only is the older building’s owner not feeling the pinch, he’s getting maximum benefits from exploiting the loopholes that have kept his assessments low.
In under 1300 words so far I have explained a clear and present problem that has been created by a poorly written law that has caused massive amounts of pain for Californians in general, but has been a financial windfall for a small handful of people. These two loopholes not only protect a small class of people, but help enrich them while passing along the pain of the loopholes to a much larger class of people.
Why does all of this matter? Because there’s a group of politicians who every election cycle sign pledges in which they promise to NOT fix the loopholes and to continue to hurt the many for the benefit of the few. These people will say that they are “signing pledges to not raise taxes,” but the pledge also means that they will not fix the loopholes in Prop 13 and correct a bad law that is hurting many in the state to the benefit of a very few.
When you started reading this you were thinking that Prop 13 is good, and in fact it does have some very good components. But these politicians’ pledges mean that they will NOT fix the loopholes. And these loopholes need to be fixed or we’ll find that more services will be cut, and more fees will be passed along to the majority so that this special minority can continue to make massive amount of profits at the expense of the majority.
The key to fixing this clear and present danger to California is to demand that our elected officials NOT sign these pledges to not fix the Prop 13 loopholes. The key way to ensure that these loopholes get closed is to demand to know from any person running for public office if they will work to close these loopholes the day that they get elected. The key is to demand accountability from those that seek our vote, and to vote only for those that will fix a broken system that has loopholes that benefit a small minority at the expense of the majority.
So listen carefully and when you hear a politician say that they have signed a pledge to “not raise taxes,” remember that means they have signed a pledge to do everything in their power to keep these special interest loopholes in Prop 13. Remember that, even though they may claim that they are working for the benefit of you and the rest of California, they’re really working for the direct benefit of those that will continue to push more of the tax burden on you, and protect the growing profits of the this special class of people. The signing of the pledge is a special message to those benefiting from the loopholes in the law today that these politicians will continue to do all in their power to make sure the playing field is stacked in their favor.
And if you’re running against one of these “tax-pledging” politicians, take the time to explain to the voters why these people are working against the interests of a majority of Californian’s and why you will focus on fixing these loopholes in Prop-13. People understand when it’s explained to them how these loopholes are hurting the majority just so a small handful can benefit by having the deck stacked in their favor.