The California State Assembly recently approved legislation amending a Proposition 13 provision that has historically allowed some commercial real estate owners, including owners and purchasers of solar energy systems, to avoid property reassessments when property or businesses that own property are sold or transferred, and therefore avoid higher property taxes. AB-2372 (the “Bill”) was brokered in a rare bipartisan deal supported by lawmakers as well as California business and anti-tax groups. It passed the Assembly on  May  29, 2014  by  a  vote of  56-8, and was sent to the Senate for consideration. If approved by two-thirds of the Senate and the Governor, the Bill would be the first change to Proposition 13 since its enactment in 1978.

The Bill eliminates a loophole commercial property owners often use to avoid reassessment when property is sold or transferred. While it is aimed at older California commercial institutions that have, over time, avoided reassessment through carefully structuring ownership changes, the Bill could have a particularly negative impact on buyers of solar energy systems currently shielded from reassessment by the Active Solar Energy Exclusion. This client alert addresses provisions of the Bill that, if signed into law, will likely affect current and future projects in California’s solar energy project marketplace.

AB-2372: THE PROPOSED CHANGE TO PROPOSITION 13

Proposition 13, which rolled back property taxes and capped how much they could increase each year, has not changed since 1978. The Bill, co-authored by Assembly members Tom Ammiano (D-San Francisco) and Raul Bocanegra (D-Pacoima), is expected to break this streak.

Under current law, commercial property is generally not subject to reassessments unless over 50% of the ownership interests are transferred to one new party.   Thus, carving up ownership so that no single party has a majority stake perpetually averts reassessment. Under the proposed law, however, a transfer of 90% of cumulative ownership in a single transaction would trigger a reassessment, regardless of whether any one party received majority interest. Under both the current law and proposed amendment, a “change of ownership” triggers reassessment. The proposed law, however, broadens the meaning of “change of ownership” to include any sale or transfer of 90% or more of the ownership interests in a legal entity in a single transaction. A “sale or transfer” includes any change of ownership interests other than those in the regular course of trading activity on an established securities market. This means that prospective commercial property buyers and parties considering a merger or acquisition will no longer be able to avoid a post-transaction commercial property tax reassessment by splitting up shares into minority portions if over 90% of the ownership in a company changes hands.

The second notable change the Bill proposes is a 50% increase in the penalty for failure to give notice of a change in ownership to the State Board of Equalization office in Sacramento. The penalty, which is based on the amount of property taxes, will be increased from 10% to 15% of the applicable property taxes. While this change may not meaningfully increase revenue for the government, it does provide a further disincentive for some of the accounting maneuvers to avoid reassessment that have become common practice for California companies in the decades since the enactment of Proposition 13.

The Bill is currently under consideration by the Committee on Appropriations, having been approved by the Committee on Governance and Finance with a 5-2 vote. In the committee stage, several staff recommendations were presented that, if incorporated into the Bill, would make reassessments even more likely by, for example, eliminating the three-year cut-off (instead providing that reassessment occurs whenever the 90% threshold is reached) or giving the Bill a retroactive effect by directing assessors to enroll new values for property that would have been reassessed under the Bill’s terms.

LOOKING AHEAD: PRACTICAL CONSEQUENCES FOR CURRENT BENEFICIARIES OF THE ACTIVE SOLAR ENERGY EXCLUSION

If approved by two-thirds of the Senate, the Bill will result in less flexibility for commercial real estate owners in California to make changes in ownership without triggering a property tax reassessment. Today, in California, the original beneficiaries of the Active Solar Energy System Exclusion for a given property are able to avoid reassessment unless one party acquires over 50% of the ownership interests in a qualifying solar project. This has historically left many options open for a buyer or group of buyers interested in purchasing over 90% of that property without forfeiting the Active Solar Energy Exclusion; essentially, they are free to structure the transfer however they please without reassessment as long as no single legal entity or person acquires more than 50%. The Bill would limit this freedom, because under the new law, no arrangement of ownership structure would exempt the owners from reassessment if 90% or more of the ownership interests are being transferred.

While the Bill is not yet law, in light of its bipartisan support, backing from California business groups like the California Chamber of Commerce, and the notable absence of opposition from anti-tax groups like the Howard Jarvis Taxpayers Association, the Bill is likely to garner the requisite two-thirds support in the Senate and be passed to the Governor. With no signal of aversion from the Senate or Governor’s office, all signs indicate that the Bill will be law in the near future. Consequently, commercial property buyers going forward will need to factor in the cost of increased property taxes into their economic evaluation of a potential land purchase, merger, or acquisition in situations where they could currently avoid reassessment and continue to pay the transferor’s lower grandfathered rate. The Senate leaders have expressed that they intend for the Senate to vote on the Bill by the end of the fiscal year.