Last month, the California Supreme Court issued its decision in Western States Petroleum Assn. v. Board of Equalization, 304 P.3d 188 (2013), which invalidated Property Tax Rule 474 regarding the valuation of refineries for purposes of property taxation. Although the Court found the State Board of Equalization (“BOE”) failed to comply properly with the requirements for creating the regulation, the ruling is – at best – a temporary victory for the petroleum refining industry. More importantly, the case not only clears the road for the BOE to reenact the very same regulation after correcting the procedural error it made during the initial rule-making process, but it also provides the BOE (and county assessors) authority to implement similar techniques for non-refinery properties in the future.
In this case, the Western States Petroleum Association (“WSPA”) brought an action against the BOE, challenging the validity of Property Tax Rule 474. Rule 474, which was enacted in 2007, provided that the value of land, improvements, and fixtures used in a petroleum refinery must be valued as one unit. Previously, fixtures were valued separately from land and improvements. Valuing the three as one unit generally leads to higher assessed values, because depreciation attributed to the fixtures is offset by appreciation in the market value of the land.
WSPA argued that Rule 474 was invalid for two reasons. First, it argued that the regulation was inconsistent with Proposition 13, and its related statutory enactments. Second, it argued that regulation was procedurally invalid because the BOE failed to assess the economic impact of the regulation as required by the California Administrative Procedures Act (“APA”).
The Court ultimately concluded that the BOE failed to make a reasoned estimate of all the cost impacts associated with the new rule, as required by the APA, and could have rested its decision on that ground. However, the Court stated that its consideration of WSPA’s substantive argument was warranted as well, because it represents a matter of considerable importance to the parties and to the public, and may serve to avoid future litigation.
With regard to the constitutional argument, the Court explained that although constitutional and statutory provisions have long required land and fixtures to be assessed separately, these classes of property do not need to be valued separately. The requirement for separate assessments was never intended to supplant the market-based approach for determining value based on the proper appraisal unit. Here, the BOE had testimony (mostly from assessors that would benefit from higher values) indicating that refinery land and fixtures are typically sold as one unit. And, although refinery based fixtures historically had been valued separately, section 51(d) of the Revenue and Taxation Code defines the term “appraisal unit” as the unit “persons in the marketplace commonly buy and sell” or the unit that is “normally valued separately.” The Court held there is no indication that the BOE is bound by the approach that has been in use for the past 30 years.
Importantly, in response to WSPA’s assertion that valuing land and fixtures together violates a central tenet of Proposition 13 by recognizing land values in excess of the base-year value cap on land, the Supreme Court stated that “Proposition 13 does not specifically cap the taxable value of land or improvements per se. Instead, Proposition 13 caps growth in ‘the appraised value of real property,’ which in this context encompasses land, improvements, and fixtures. To say that Rule 474 violates Proposition 13 by allowing taxation of unrealized land value above the Proposition 13 cap is to assume that land, by itself, must be treated as a separate appraisal unit for purposes of real property taxation.” Western States, at 200-201 (citations omitted). Although the Court was discussing Proposition 13 in the context of defining the proper appraisal unit, the language seems to imply that the specific allocations of value to land and improvements do not have to comply with Proposition 13 as long as the total “real property” value does not exceed the factored base year value for all of the subject real property. As stated by the Court, “when land and fixtures are typically sold as a single unit, they are properly treated as a single appraisal unit, even if fixture depreciation is offset by land appreciation or otherwise reduced by valuing land and fixtures together.” Western States, at 201. In other words, if a commercial property’s land, improvements, and fixtures are typically sold as a single unit, the annual depreciation assigned to the property’s fixtures may be offset by an increase in the land and/or building values. “To account for fixture depreciation separately when land and fixtures are actually bought and sold as a single unit would allow the owner to claim a reduction in real property value that is economically fictitious, resulting in a tax windfall. Neither California Constitution article XIII A nor section 51 nor traditional appraisal practices require the unit of appraisal to be defined in a manner that maximizes the depreciation of fixtures in contravention of economic reality.” Id.
The case does not expressly state that its analysis applies to other industries where land, improvements, and fixtures are, ostensibly, sold as a single unit. Nevertheless, assessors across the State are undoubtedly organizing to identify the next target industry, now that the Supreme Court has laid out a roadmap on how to attain higher assessed values by redefining the appraisal unit. Of course, arguments could (and likely will) be made to the contrary, e.g., alleging that land and/or improvement values must be reduced to acknowledge the presence of obsolete or depreciated fixtures within a broader-defined appraisal unit. Either way, however, practitioners see the Court’s ruling on the substantive issue as an invitation for more disputes – not less, as the Court sought to achieve.