California Proposition – 13 Urgent Change in the Tax Law Coming: Act Before January 1, 2015 Or Lose a Priceless Planning Opportunity

Dear Clients, Colleagues, and Friends,

Imagine with me for a moment that you have the opportunity to purchase a “trophy” property like the historic and beautiful Fairmont Miramar Resort in Santa Monica. Of course, being the savvy business person you are, and given the $200,000,000 price tag, your legal team is involved in the acquisition, and they properly inform you that you may be able to structure the transaction in such a way that reassessment of the property’s value could be avoided by carefully following the rules exempting taxable assessments under CA Proposition 13.

Your legal team advises you that it would be completely legal, and would avoid reassessment of the property’s value to current purchase price, if your spouse and two business partners were involved in the purchase, and none of the four of you individually owned more than a 49% interest in the entity owning the property. By carefully following this plan, you could preserve the hotel’s 1999 assessment of $86,000,000 for property tax purposes, 43% of its current value. Why not, if the law allows it?

This is exactly what Michael Dell’s lawyers advised him when he decided to purchase the resort in 2006. And that sort of structured transaction is not an uncommon one, as currently Proposition 13 does not require property tax reassessment unless more than 50% of an ownership interest is transferred to a new party. L.A. county assessor’s office disagreed with the transaction and assessed the property as though the exemptions were not applicable. The parties sued, and after a long and expensive legal battle, Michael Dell prevailed and, as a result, he will save over $1.2M in property taxes every year going forward until he disposes of the property.

To make sure this transaction could never happen again, on May 29, 2014, the California State Assembly approved bipartisan legislation, which has the potential to amend California Proposition 13, and, in so doing, close that very loophole which has in the past allowed commercial real estate owners to avoid real property tax reassessments in carefully structured transactions. Under Assembly Bill 2372, which may garner the two-thirds vote of the Senate and the Governor by the end of the year, if, on or after January 1, 2015, 90% or more of the direct or indirect ownership interests in a legal entity are cumulatively transferred in one or more transactions, the transfer of the ownership interest would constitute a change of ownership of the real property owned by the legal entity.

Further, the proposed Bill would increase the penalty for failure to give notice of a change in ownership to the State Board of Equalization within 90 days of the date the ownership change occurs from 10% to 15% of the applicable property taxes. The hike in penalty costs should provide a decently-sized deterrent to those who would otherwise try to avoid the reassessment, especially for highly valued pieces of property.

So, the lesson here is this: If you have low tax basis property and wish to avoid the reassessment when you or your estate plan devolves the properties to the next generations, you should do your planning now and be careful not to run afoul of the 50% ownership test.

Posted in Client Alert.