Proposed New Business Tax Structure in San Francisco

On May 6, 2024, a new San Francisco business tax initiative was filed in order to qualify for the November 2024 ballot.  The purpose of the initiative is to remedy Covid-19’s major impact on the San Francisco economy, including remote work.  According to the San Francisco Tax Collector’s website, the initiative was proposed by  Controller Greg Wagner, former Controller Ben Rosenfield, Chief Economist Ted Egan, and San Francisco Treasurer Jose Cisneros.  San Francisco Leaders Support Business Tax Reform Proposal to Strengthen City Economy | San Francisco (sf.gov).  The San Francisco Chronicle states the proposal was filed by two “business leaders” but is supported by Mayor Breed and Board of Supervisors President Aaron Peskin. https://www.sfchronicle.com/sf/article/s-f-economy-tax-plan-19444049.php.

According to the Tax Collector, the key elements of the proposal are:

  • Exempting more than 2,500 small businesses from the tax by expanding the Small Business Exemption to $5 million dollars
  • Lowering taxes for hotels, arts, entertainment, and recreation
  • Reducing volatility by ensuring taxes are not overconcentrated
  • Reducing disincentives for bringing workers back or locating in San Francisco
  • Simplifying the overall tax structure to be more predictable

According to the San Francisco Chronicle, post-pandemic, the five largest taxpayers in the City accounted for 24% of all business taxes, and remote work reduced the City’s business tax revenue by $484 million in 2021. https://www.sfchronicle.com/sf/article/remote-work-reduced-s-f-s-taxes-484-million-18193946.php   The loss of tourists and workers in the City has devastated the retail, restaurant and hotel industries. For some businesses, the proposed tax initiative would be a welcome shift from the ever increasing taxes and fees imposed by the City.  However, the decreased income would be made up by increase on other types of commercial activities.

The measure keys on some of the businesses most impacted by the loss of workers in San Francisco, including retail, restaurants, and hospitality.  Unfortunately for the owners of empty office buildings, there would be no reduction in the commercial rents tax. If passed by the voters, the 2024 tax ordinance would result in a significant change in the business tax structure, including revised gross receipts tax rates, short term decreases in the Homelessness Gross Receipts Tax and Overpaid Executive Tax, and a temporary reduction in business registration fees.  The measure would also provide key incentives for small businesses, certain new office building occupants, and grocery stores. Finally, the new tax plan would shift the calculation of business taxes away from the partial reliance on San Francisco based payroll (i.e., lower because of remote work), and focus more on gross receipts, in an effort to more evenly allocate the tax burden and lure workers back to San Francisco.

The proposal is quite detailed and technical in nature.  The Tax Collector’s office has issued a summary of the key changes and expected impacts of the ordinance, and a link to that summary is attached here.  PowerPoint Presentation (sf.gov)

The following are a few additional components of the proposal (some of which are from the Tax Collector’s analysis):

  • Enacts a new small business exemption from the Gross Receipts Tax for businesses that make less than $5 million per year (with annual CPI adjustments). Importantly, residential landlords do not qualify for this exemption.
  • Tax credits of up to $1M for those that open a new business in the City (that person or combined group cannot have operated in the City for the past three years) in certain “Designated Areas”
  • Tax credits for companies that lease all or a portion of a “Qualified Building” for office purposes (“Qualified Building” means that construction must have started between Nov. 4, 2024 and Nov. 4, 2029 and be at least 450,000 square feet, among other requirements), and house at least 100 employees in such building.
  • Gross Receipts tax rates would be reduced for certain industries, including retail, recreation, food service, and hotels.
  • Gross Receipts tax rates would increase significantly (almost double for firms making over $5M per year) for financial and legal services (i.e., attorneys and accountants), and these businesses would lose the ability to reduce the tax due to non-San Francisco employees.
  • The construction industry would be hit with increased tax rates for income above $2.5 million.
  • No significant change in gross receipts tax rates for real estate leasing activities.
  • Tax credits for supermarkets and other grocery retailers (excluding convenience stores) of 0.5% of these company’s taxable gross receipts, up to a maximum credit of $4 million.
  • Reduces the tax rate on Administrative offices based on payroll expenses in San Francisco from 1.54% in 2024 to 1.47% in 2025 and 2026.
  • Reduce the Overpaid Executive Tax by 80%.
  • The Homelessness Gross Receipts Tax, previously charged only to companies making $50 million annually, would be modified to reduce the income threshold to $25 million starting in 2025 (except for the real estate category, where the threshold remains at $50 million).

If the proposed tax plan qualifies for the ballot and passes, it would be a strong signal that San Francisco has turned away from the theory that higher taxes do not impact San Francisco businesses, and recognition that a reasonable tax structure is necessary to attract at least certain types of companies.  However, some industries would still be subject to the more aggressive tax structure, and taxes would still increase in later years. It will be interesting to see if this plan is enough to attract more business to San Francisco.

 

Authored by Reuben, Junius & Rose, LLP Partner Kevin Rose.

The issues discussed in this update are not intended to be legal advice and no attorney-client relationship is established with the recipient. Readers should consult with legal counsel before relying on any of the information contained herein. Reuben, Junius & Rose, LLP is a full service real estate law firm. We specialize in land use, development and entitlement law. We also provide a wide range of transactional services, including leasing, acquisitions and sales, formation of limited liability companies and other entities, lending/workout assistance, subdivision and condominium work.

Voters Approve Mayor’s Transfer Tax Exemption

The Mayor’s proposal to waive San Francisco’s Transfer Tax for certain converted residential space (“Measure C”) was approved by voters on March 5, according to the City of San Francisco’s official preliminary election results. We previously provided an overview of this measure that is aimed at encouraging conversion of office to residential use in the City on October 25, 2023.

Generally, under the new law, up to the first 5,000,000 square feet of “Converted Residential Property” can be exempted from the City’s Transfer Tax. Conversions that involve demolition of nonresidential property to construct new residential property may also be considered Converted Residential Property subject to the tax exemption.

However, the measure caps the amount of new square footage that can be considered Converted Residential Property. For projects where a building is demolished to construct new residential property at the same site, the amount of Converted Residential Property only includes residential square feet in the new building that exceeds the square feet of any residential space in the demolished building, up to a maximum of the total gross floor area of the non-residential space in the demolished building, plus 10%.

According to SPUR, the approval of Measure C comes with the following benefits:

  • Acceleration of office to residential conversion projects can speed downtown recovery through reducing the cost of development;
  • Activating obsolete office buildings with housing can increase foot traffic and economic activity;
  • The Board of Supervisors can make future changes to the transfer tax as needed legislatively, allowing flexibility for the City to make adjustments based on economic conditions

The tax exemption under Measure C applies to the First Transfer of Converted Residential Property—meaning the first transfer after a certificate of final completion and occupancy or temporary certificate of occupancy is issued for the property, whichever is earlier. So, projects will generally see the benefits of Measure C once construction is complete.

The passage of Measure C alone is not expected to close the feasibility gap for most office to residential conversion projects, and additional incentives will be needed to make such projects financially viable.

Authored by Reuben, Junius & Rose, LLP Attorney Kaitlin Sheber.

The issues discussed in this update are not intended to be legal advice and no attorney-client relationship is established with the recipient.  Readers should consult with legal counsel before relying on any of the information contained herein.  Reuben, Junius & Rose, LLP is a full service real estate law firm.  We specialize in land use, development and entitlement law.  We also provide a wide range of transactional services, including leasing, acquisitions and sales, formation of limited liability companies and other entities, lending/workout assistance, subdivision and condominium work.

Summer SF Legislation Roundup

summer

Below is a round-up of some items introduced before the Board of Supervisor’s summer recess, which will run from July 31st to September 4th.

Update to Ordinance That Would Expand Allowable Commercial, Restaurant, and Retail Uses

In early June, Mayor Breed and Supervisors Engardio, Dorsey, and Melgar introduced an ordinance aimed at reducing zoning restrictions to allow more types of commercial use on the ground floor of certain neighborhood commercial and residential districts.

For an in-depth overview of this legislation, see our June 22nd update.

On July 25th, the Mayor substituted an amended version of this legislation.  It has been assigned to the Land Use and Transportation Commission, where it will likely be heard in the early fall.

Changes in the updated version appear minor, and include:

  • allowing formula retail restaurants with conditional use authorization at the ground floor in the Mission Street Formula Retail Restaurant Subdistrict;
  • retaining the flat prohibition on formula retail pet supply stores or restaurants in the Geary Boulevard Formula Retail Pet Supply Store and Formula Retail Eating and Drinking Subdistrict;
  • correcting the summary description of maximum number of eating and drinking uses that would be allowed in the Mission Street NCTD to 197 (from 179); and
  • clarifying that formula retail and restaurant controls would be amended in certain residential districts, as well as commercial districts.

A Tweak to Prop X

Section 202.8 of the Planning Code, enacted by voters in 2016 as “Prop X”, limits projects that would convert Production, Distribution, and Repair (“PDR”) uses, Institutional Community uses and Arts Activities uses in certain Eastern Neighborhoods Plan areas and Central SoMa.

With limited exemptions, Prop X imposes specific replacement requirements for projects that would convert building space where the prior use was:

  • a PDR use of at least 5,000 square feet;
  • an Institutional Community use of at least 2,500 square feet; or
  • an Arts Activities use.

On July 25th, Supervisor Dorsey introduced an ordinance that would create an exemption from Prop X replacement requirements for projects proposing change of use from one of the listed uses above to another listed use, or to new Institutional Education uses, in areas zoned SALI, MUO, SLI, MUG or MUR as of July 1, 2016. This could allow for a more efficient change of use process, encouraging continued use of buildings.

This legislation would require a supermajority vote (i.e., 8 members) of the Board to pass, and has been assigned under the Board’s 30-day rule to the Land Use and Transportation Committee for review.

Vacant Storefront Fee Waivers

Currently, owners of vacant or abandoned commercial storefronts are required to register the storefront with the Department of Building Inspection (“DBI”) within 30 days of a vacancy or abandonment, pay an annual registration fee, and to renew the registration annually.

On July 25th, Mayor Breed introduced an ordinance that allows the Director of DBI to waive the annual registration fee for storefronts that comply with City and state law, do not contribute to blight as defined by the Administrative Code, and are ready for occupancy and being offered for sale, lease, or rent.

This ordinance has been referred to the Building Inspection Commission for comment and recommendation.

Reduction of Entertainment Permit Requirements

On July 25th, Mayor Breed introduced an ordinance that could reduce entertainment permit requirements citywide, encouraging a sector that will draw in locals and tourists alike.

The ordinance, which has been referred to the City’s Small Business Commission for review, would do the following:

  • waive the initial license and filing fees through June 30, 2025, for certain Entertainment Permits for current or former holders of Just Add Music Permits;
  • waive initial license and filing fees for Entertainment Permits for applicants who are newly eligible to apply for those permits due to recent Planning Code amendments;
  • eliminate masked ball permits;
  • require applicants for Arcade, Ancillary Use, billiard and pool table, Place of Entertainment, Limited Live Performance, Fixed Place Outdoor Amplified Sound, and Extended-Hours Premises Permits to submit a new Permit application and filing fee if their existing application has not been granted, conditionally granted, or denied within 12 months of its submission;
  • authorize the Entertainment Commission Director to issue billiard and pool table permits without a hearing, and allow them to be suspended or revoked under the standards that apply to other Entertainment Permits;
  • eliminate the requirement that applicants for Place of Entertainment Permits disclose criminal history information regarding certain individuals connected with the applicant business;
  • narrow the categories of new criminal charges, complaints, or indictments brought against a Place of Entertainment Permittee or its employees or agents that the Permittee must report, to only those charges, complaints or indictments that could be grounds for suspension of the Permit; and
  • allow the Entertainment Commission Director to require an applicant for a Limited Live Performance Permit to propose a Security Plan if necessary to protect the safety of persons and property or provide for the orderly dispersal of persons and traffic, to make compliance with the Security Plan a condition of the Permit, and to require revisions to the Security Plan as necessary.

Decline in Value Tax Appeals are Due Soon

Tax bills are in the mail for the 2023/2024 tax year.  Many commercial owners have experienced a decline in income and property value due to reduced occupancy and rental rates.  Some residential neighborhoods have also declined in value.  The good news is that there is the possibility for some temporary real estate tax relief.  Property owners have the right to file decline in value appeals (also referred to as Prop. 8 appeals) to account for such market conditions.  The deadline for properties located in San Francisco is September 15, 2023.  Alameda County’s deadline is also September 15, 2023.  Contra Costa County and San Mateo County give a bit more time – November 30, 2023 is their deadline.  (Deadlines are taken from each County’s website.)

If you would like more information about a real estate tax appeal, contact Kevin Rose at krose@reubenlaw.com.

 

Authored by Reuben, Junius & Rose, LLP Attorney Melinda Sarjapur.

The issues discussed in this update are not intended to be legal advice and no attorney-client relationship is established with the recipient.  Readers should consult with legal counsel before relying on any of the information contained herein.  Reuben, Junius & Rose, LLP is a full service real estate law firm.  We specialize in land use, development and entitlement law.  We also provide a wide range of transactional services, including leasing, acquisitions and sales, formation of limited liability companies and other entities, lending/workout assistance, subdivision and condominium work.

HCD Cracks Down on S.F. Housing Practices; S.F. Real Estate Tax Appeal Deadline

HAU

Last month, the State Department of Housing and Community Development (“HCD”) announced that its Housing Accountability Unit (“HAU”) will conduct a first-ever Housing Policy and Practice Review of San Francisco, aimed at identifying and removing barriers to approval and construction of new housing in the City. According to the City’s self-reported data, it has the longest timelines in the state for advancing housing projects to construction, among the highest housing and construction costs, and the HAU has received more complaints about San Francisco than any other local jurisdiction in the state. U.S. Census data shows that Seattle – a city of comparable size – approves housing construction at more than three times the rate of San Francisco.

Over the next nine months and beyond, the HAU, in partnership with the U.C. Berkeley Institute of Urban and Regional Development and others, will conduct a comprehensive analysis of San Francisco’s housing approval policies and practices. The review will examine discretionary decision-making patterns that lead to abnormally long housing delays. The review also intends to identify barriers to the approval and development of housing at all income levels, including housing that is affordable to lower- and moderate-income households.

Separately, in an August 8 letter to Planning Director Rich Hillis, HCD was both critical and encouraging of the City’s Draft Housing Element. California cities are required to update their General Plan Housing Elements by January 2023. HCD praised the City’s “bold and meaningful actions to both reduce barriers to higher-opportunity neighborhoods while simultaneously reinvesting in historically underserved neighborhoods.” Yet HCD also identified a number of revisions that would be necessary for the Housing Element to comply with state law.

In yet another letter on August 11, HCD asked the City to explain itself concerning a specific project approval, expressing concern that the City violated housing law. HCD was concerned with the City’s decision, in granting conditional approval, to downsize a 19-unit group housing project at 3832 18th Street in the Mission District. HCD expressed concern that the downsizing violated the State Density Bonus Law.

This project-specific letter follows HCD’s letter to the City last November expressing concern that the City’s denial of two large housing projects, at 450 O’Farrell Street and 469 Stevenson Street, may have violated state law. In those cases, the Planning Commission had approved the projects, but the Board of Supervisors denied them.

The aforementioned Housing Accountability Unit at HCD is part of an unprecedented new initiative to support the production of housing statewide. According to its website, “California’s housing crisis has reached historic proportions despite the passage of numerous laws intended to increase the supply of housing affordable to Californians at all income levels.” As part of the 2021-2022 state budget, HCD received additional staff to grow its accountability efforts and formed the HAU. The HAU holds jurisdictions accountable for meeting their housing element commitments and complying with state housing laws. One of its primary tools is technical assistance to the public and enforcement letters. More information on these powers is available at the HCD website.

San Francisco Real Estate Tax Appeal Deadline

The deadline for San Francisco property owners to appeal their property’s value for the 2022/2023 tax year is September 15, 2022.  Deadlines for other California counties vary.  Please contact Kevin Rose (krose@reubenlaw.com) if you have questions about the tax appeal process.

 

Authored by Reuben, Junius & Rose, LLP Attorney Thomas P. Tunny.

The issues discussed in this update are not intended to be legal advice and no attorney-client relationship is established with the recipient.  Readers should consult with legal counsel before relying on any of the information contained herein.  Reuben, Junius & Rose, LLP is a full service real estate law firm.  We specialize in land use, development and entitlement law.  We also provide a wide range of transactional services, including leasing, acquisitions and sales, formation of limited liability companies and other entities, lending/workout assistance, subdivision and condominium work.

Proposition C Upheld by Court of Appeal

Proposition C

California’s First District Court of Appeal (“Court of Appeal”) has rejected arguments from business and tax groups challenging the validity of San Francisco’s Proposition C, the Early Care and Education initiative.  The Court of Appeal held that citizen initiatives to enact a special tax only require a simple majority vote to pass, even if an elected official is involved in the citizen initiative process. This decision could be a game-changer in how tax measures are processed in the future, causing legislators to convert proposed tax measures into citizen-initiated measures, i.e. allowing politicians in California to use the citizen initiative’s simple majority vote requirement to avoid the more strenuous two-thirds supermajority vote local governments must obtain to increase taxes. San Francisco City Attorney Dennis Herrera described the ruling as “a victory for voters and a victory for democracy.”

Background

Proposition C, a citizen initiative, was approved by City of San Francisco voters on the June 5, 2018 ballot. This commercial rent tax was expected to raise up to $145 million annually for childcare and early education services by taxing business revenues from commercial space rentals by 3.5% and warehouse space rentals by 1% where receipts are over $1 million. Norman Yee, at the time a member of the City’s Board of Supervisors, was the driving force behind citizen initiative Proposition C. He completed the key steps required to put a citizen initiative on the ballot— he both turned in the signed initiative petition pages and signed the ballot arguments in support of Proposition C.

In San Francisco, there are two different ways special taxes are imposed: (1) local governments may present a special tax to the voters, but voters must approve the special tax by a super majority two-thirds vote, or (2) local citizen initiatives may present special taxes to the voters after receiving a threshold number of signatures. Citizen initiatives only require a simple majority vote to pass.

After Proposition C was approved by a 51% majority of voters, the Howard Jarvis Taxpayers Association quickly joined forces with other business-related groups (“Plaintiffs”) to challenge the initiative, arguing the measure needed a two-thirds supermajority vote to pass because an elected district supervisor put forward the measure. Though the City has collected tax funds from businesses since the passage of the proposition, the money was not spent during the legal challenge. A San Francisco Superior Court judge rejected Plaintiffs’ arguments in July 2019. The decision was affirmed by the Court of Appeal on January 27, 2021. Now, Plaintiffs are planning to appeal the most recent decision to the California Supreme Court as the Court has not previously ruled on this issue.

Legal Reasoning

The Court of Appeal adopted the reasoning of a recent case in another division of the same court, City and County of San Francisco v. All Persons Interested in the Matter of Proposition C (2020) 51 Cal.App.5th 701 (“All Persons”), to reject Plaintiffs’ appeal arguments. First, All Persons noted the initiative power is “one of the most precious rights” of the democratic process, so courts must both guard and liberally construe the exercise of the power. Accordingly, the court held Proposition 13 only requires governmental entities to gain two-thirds supermajority voter approval before imposing a special tax. Next, the court held Proposition 218, which requires a two-thirds supermajority when local government imposes a special tax, did not apply because the electorate is not “local government.” Finally, the court held that the City Charter did not require a two-thirds supermajority to pass a special tax because the Charter only creates substantive limits on the initiative power, not procedural limitations.

Plaintiffs argued their action challenging Proposition C was distinguishable from All Persons because Norman Yee was an elected official serving on the Board of Supervisors. The court rejected this argument, holding that Propositions 13 and 218 did not require a two-thirds vote to pass special taxes where an elected official was involved in the citizen initiative process. Plaintiffs will appeal to the California Supreme Court, noting this decision allows politicians in California to circumvent the two-thirds voter approval requirement for special taxes by turning special tax proposals into citizen initiative petitions.

 

Authored by Reuben, Junius & Rose, LLP Attorney Kaitlin Sheber.

The issues discussed in this update are not intended to be legal advice and no attorney-client relationship is established with the recipient.  Readers should consult with legal counsel before relying on any of the information contained herein.  Reuben, Junius & Rose, LLP is a full service real estate law firm.  We specialize in land use, development and entitlement law.  We also provide a wide range of transactional services, including leasing, acquisitions and sales, formation of limited liability companies and other entities, lending/workout assistance, subdivision and condominium work.

Unforeseen Effect of Proposition 19

Proposition 19

Despite San Francisco’s reputation as a high-rent city, it maintains a substantial inventory of older, lower-rent units that primarily cater to working- and middle-class renters. The prevalence of these units arises from a combination of factors: strong rent-control laws and eviction protections, combined with favorable tax treatment under Proposition 13 and subsequent parent-child transfer exemptions passed in the 1980s. These transfer exemptions guaranteed Proposition 13’s low property taxes over multiple generations, creating an incentive to preserve rather than sell, upgrade, or redevelop low-cost rental inventory.

On November 3, 2020, California voters narrowly approved Proposition 19, or The Home Protection for Seniors, Severely Disabled, Families, and Victims of Wildfire or Natural Disasters Act, which amends Article XIIIA of the California Constitution and will remove all transfer exemptions for rental properties. Without these exemptions, the coming decades will see increased taxes on inherited rental properties which will likely force many small property owners out of this lower-cost niche and lead to the gradual erosion of this segment of the rental market.

History of Property Tax and Transfer Exemptions (Propositions 13 and 58)

In 1978, Proposition 13 set a uniform property tax in California at a rate of 1% on a property’s assessed value. The value of a property is assessed on the date of transfer and is limited to a 2% yearly increase unless there is another transfer (or substantial rehabilitation). No matter how high a property’s value climbs, the tax rate will grow at a slow, predictable pace. In 1986, Proposition 58 added transfer exemptions, which created an exemption for parent-child transfers and allowed parents to transfer rental properties to their children up to $1,000,000 in assessed value (or $2,000,000 for married couples) before a reassessment was triggered on the overage. This gave families the ability to sustain the advantages of tax rates secured by decades-old purchases.

Effects of Proposition 13 on the Rental Market

In high demand rental markets, lost profit opportunities on older or rent-controlled units generally drive owners to redevelop or sell their properties in order to take advantage of rising demand and rental rates. Proposition 13, however, offers a counterbalance for longstanding owners by assuring a steady tax bill and predictable operating costs which guarantees ongoing stability for these owners.

Even in a market like San Francisco’s, the effects of Proposition 13 can be seen in the durable collection of older and rent-controlled buildings that make up large swaths of the city’s rental offerings. Incremental tax increases and predictable operating costs allow these buildings to generate a consistent level of profit, even when rents are low due to rent control or aged facilities. This consistent income with minimal intervention persuades many owners to forgo chasing the market and risk endangering their investment.

The long-term preservation of these buildings at low rates results in a consistent stock of housing for lower-income renters. Under the parent-child transfer exemption, families could pass down their rental properties without impacting their consistent investment income. This security protects both the owner and the continued availability of these units by disincentivizing drastic changes to these family investments.

Proposition 19 and the Erosion of Affordable Rentals

With Proposition 19 slated to remove transfer exemptions for rental properties, the taxes on inherited rental properties will see an immediate surge as assessments rise to meet market value. In a real estate market that has seen forty years of unprecedented growth, these increases could easily be tenfold or more.

With tax increases cutting deeply into the already below-market profits of these buildings, inheriting owners will see little of the stability that convinced their parents to maintain these properties. Proposition 19’s effects will reveal numerous issues as the situation develops over the coming years. For instance, an inherited older building may be unable to sustain a profit at the market rate for comparable buildings which still retain a low tax basis. These owners would be unable to compete and be forced to upgrade or sell their units, speeding up the loss of vital rental inventory.

Other issues that could arise could be disparate taxes on comparable buildings depending on when in the boom-bust cycle they were reassessed, leading to potentially different tax bills. Further, the recent rental impacts of Covid-19, with high vacancies, rent reductions, and non-paying tenants, alert us to numerous situations where high taxes on historically low-profit units will threaten viability and drive owners to sell or redevelop.

San Francisco has a large population dependent on older units, with more than 62% of renters living in rent-controlled buildings. Many of these buildings are only profitable because Proposition 13 has protected owners and their tenants from market forces for decades and allowed them to stay afloat. With the loss of these protections, Proposition 19 will accelerate the loss of this housing as desperate owners seek ways to maintain viability.

 

Authored by Reuben, Junius & Rose, LLP Attorney Daniel J. Turner.

The issues discussed in this update are not intended to be legal advice and no attorney-client relationship is established with the recipient.  Readers should consult with legal counsel before relying on any of the information contained herein.  Reuben, Junius & Rose, LLP is a full service real estate law firm.  We specialize in land use, development and entitlement law.  We also provide a wide range of transactional services, including leasing, acquisitions and sales, formation of limited liability companies and other entities, lending/workout assistance, subdivision and condominium work.

Real Estate Tax Update

Tax

Deadline to File Real Estate Tax Appeals for the 2020/2021 Tax Year

For property owners that disagree with their property valuation for the 2020/2021 tax year, the deadline to file an appeal is Tuesday, September 15, 2020. For property located in other counties, owners should check with the local Assessment Appeals Board. Unfortunately, these appeals would relate to the property value as of January 1, 2020, so the economic impact of Covid-19 is not likely to be considered. If you have questions about this, please contact Kevin Rose at krose@reubenlaw.com.

Commercial Properties May Lose Proposition 13 Protection

After many years of planning and political maneuvering, the opponents of Proposition 13 have settled on a ballot initiative, Proposition 15 (also known as the “Split Tax Roll”), to drastically overhaul California’s property tax structure. Proposition 13 is California’s landmark law, embedded in the Constitution that protects owners from increases in real estate taxes in excess of two percent per year. As a compromise to help ensure passage, residential property would be exempt from the tax increase.

The Basics

If passed in this November’s general election, Proposition 15 would require commercial and industrial properties to be reassessed every three years at the full fair market value of the property, as determined by County Assessors. This new assessment would be used to calculate property taxes based on the statutory tax rate, which is also limited to 1% by Proposition 13 and would remain unchanged. There would be no limit on reassessment, so many property owners could experience significant increases in real property taxes. This would wipe out the ability of property owners to plan for stable property tax increases of no more than 2% per year, and authorize County Assessors to exercise their discretion in determining the “fair market value” of real estate. Residential property, including multi-family structures (apartments), is specifically excluded from reassessment, as is commercial agricultural property.

Why Increase Taxes?

The proponents of Proposition 15 argue that commercial and industrial properties are underassessed and avoid over $11 Billion in local property taxes, which should be used to support schools, local governments and affordable housing. Advocates cite an unnamed University of California study claiming that such reassessment of commercial property will have a “net positive benefit” on jobs and the California economy. There was little discussion in the findings about the potential impact on tenants of commercial properties due to higher rents and expense pass throughs, other than the deferment for properties with at least 50% small business occupancy, discussed below. The opposition argues that this is the first step in completely dismantling Proposition 13.

The Process and Procedures for Reassessment

Starting with the 2022-2023 tax year, each County Assessor would be tasked with reassessing commercial and industrial properties to determine the value for property tax purposes. This process would be phased in over two years. Proposition 15 requires the creation of a task force comprised of different interests to recommend the statutory and regulatory details for implementation. Taxpayers would be given a “reasonable” timeframe during which to pay any tax increases. Such time frame is not defined and would have to be determined by the Legislature.

Proposition 15 imposes the burden of proof on the taxpayer with regard to any valuation disputes. Under current law, escape assessments (assessments for tax years later than the tax year the reassessment event occurred) or increased assessments due to change of ownership that are different than the purchase price require the Assessor to prove that the reassessment is justified. Property owners will likely be concerned that, due to political pressure to increase revenues, the Assessor will favor increases in value when there is any conflicting or disputed information. Local assessment appeal boards will almost certainly see a major increase in real estate tax appeals.

Some Properties Worth $3M or Less May Be Excluded

Small property owners are exempt from future reassessments if their property is worth $3 Million or less, but only after one reassessment under Proposition 15. This $3 Million threshold would be adjusted every two years for inflation, starting in 2025. This exception excludes “wealthy” property owners. This means if any owners of such low value property also own other property worth more than $3 Million, then the exception would not apply. The taxpayer has the burden of making this claim with the applicable County Assessor. The decision of County Assessors with regard to these exceptions are deemed to be final, and not subject to appeal to the local assessment appeals board, and judicial review of this exception is limited to “abuse of discretion.”

Small Business Temporary Exception

Properties that are used primarily (50% or more) for a small business, are exempt from reassessment, but only until 2025-2026. Small businesses are simply defined as businesses with less than 50 full time employees, provided that such business owns real property in California (not necessarily the same property) and is independently owned and operated. It is unclear if franchises are excluded, but it seems that the intent is to exclude franchise businesses from the exception.

The Personal Property Tax Exemption

As an incentive to the business community for support (apparently focusing on technology companies), up to $500,000 of tangible personal property and fixtures are exempt from taxation. This excludes airlines and boats. Also, small businesses (as defined above) would be fully exempt from taxation of personal property.

Use of Funds and Administration

Proposition 15 requires that all funds generated by these tax increases be distributed to community colleges (11%) and to school districts, charter schools and county offices of education (89%). There are complicated formulas and reporting requirements included as part of the administrative provisions. Each county and city is required to be compensated for additional costs incurred due to implementation of the reassessment requirements. Apparently, the payments are from the general fund, not the new tax revenues. The spending limitations in the California Constitution would not include any revenue generated by Proposition 15.

The Fight

While normally any proposed change to Proposition 13 would be highly contested, Covid-19, social unrest and the divisive presidential election may limit the publicity and focus on Proposition 15. The California Democratic Party, Bernie Sanders, and the San Francisco Board of Supervisors support Proposition 15. Opponents include the Howard Jarvis Taxpayers Association, The California Business Roundtable, the NAACP, and the California Business Properties Association. According to Ballotpedia, Proposition 15 had a 6% lead in the polls as of April 2020, with a 3% margin of error. Typically, new taxes need a large lead prior to the election as many voters become skittish when actually voting. It will be interesting to see how the voters feel about increasing taxes during recessionary times.

 

Authored by Reuben, Junius & Rose, LLP Attorney Kevin H. Rose.

The issues discussed in this update are not intended to be legal advice and no attorney-client relationship is established with the recipient.  Readers should consult with legal counsel before relying on any of the information contained herein.  Reuben, Junius & Rose, LLP is a full service real estate law firm.  We specialize in land use, development and entitlement law.  We also provide a wide range of transactional services, including leasing, acquisitions and sales, formation of limited liability companies and other entities, lending/workout assistance, subdivision and condominium work.

San Francisco Tax Update

Tax

Homelessness Gross Receipts Tax Upheld

On June 30, 2020, the First District of the California Court of Appeal upheld the legality of the City and County of San Francisco’s “Homelessness Gross Receipts Tax.” This tax ranges from 0.175% – 0.690% of taxable gross receipts (depending on the industry), and is 1.5% for administrative offices. This tax is imposed on companies that earn more than $50M per year in the City and County of San Francisco. In upholding the tax, the Court of Appeal found that the Constitutional right of California voters to pass laws by initiative and a majority vote, is superior to the limitations on new taxes or special taxes which require a supermajority, 2/3 vote. The Court agreed with the City that because the tax was initiated by the people, and not the government, then only a majority vote was required. The Howard Jarvis Taxpayers Association has filed a notice of appeal to the California Supreme Court, so this may not be the last word on the issue.

A copy of the court’s decision may be found here. Prop C Appellate Opinion

Commercial Rent Tax Appeal Remains in Process

The challenge to the San Francisco Commercial Rent Tax (funds for early childhood education) remains active in the First District of the California Court of Appeal. The Commercial Rent Tax is 3.5% for offices and 1.5% for Industrial space. Retail is generally excluded.

Appellants’ arguments include (1) that politicians cannot use the citizens’ initiative process as a loophole to avoid the 2/3 vote requirement, (2) voters cannot exercise power that the Board of Supervisors does not have (i.e., a majority vote standard), and (3) that the requirements of Propositions 13 and 218 should apply because the decision in the Cannabis case cited by the City related to a procedural requirement, not the actual approval of the tax at issue. The appellants’ reply brief is due July 23, 2020. Given the decision on the Homelessness Gross Receipts Tax, it seems likely that the Commercial Rent Tax will also be upheld, and there will be a showdown in the State Supreme Court. Stay tuned.

A copy of appellant’s brief may be found here. Appellant’s Opening Brief

Protective Refund Claims

In order to protect their rights to refunds, San Francisco taxpayers that are subject to the Homeless Gross Receipts Tax or the Commercial Rents Tax and wish to preserve their rights should file a protective request for refund with the San Francisco Tax Collector. Once the request is rejected, a Claim for Refund should be filed with the San Francisco Controller. Otherwise, refund claims may not be honored if the Supreme Court strikes down the tax.

The following is a link to the request for refund form and filing information. Refund Form

There may be other basis for challenging the taxes, including potential equitable arguments, that should be referenced when filing these requests/claims. You should consult with legal counsel or a tax representative to verify the process.

 

 

Authored by Reuben, Junius & Rose, LLP Attorney Kevin Rose.

The issues discussed in this update are not intended to be legal advice and no attorney-client relationship is established with the recipient.  Readers should consult with legal counsel before relying on any of the information contained herein.  Reuben, Junius & Rose, LLP is a full service real estate law firm.  We specialize in land use, development and entitlement law.  We also provide a wide range of transactional services, including leasing, acquisitions and sales, formation of limited liability companies and other entities, lending/workout assistance, subdivision and condominium work.

San Francisco Tax Battles Continue

San Francisco

Much has been written about the social ills facing the greater San Francisco Bay Area, what solutions have potential to make an impact, and to what extent the business community should be required to fund them.  Debate raged in advance of the November 2018 election, when approximately 61% of San Francisco voters passed a gross receipts tax on some businesses to fund homelessness and mental health services.  The arguments were revisited in June of 2018, when competing commercial rents tax measures were proposed to provide additional funds to housing and homeless services or fund childcare and early education.  The latter measure passed with approximately 50.87% of the vote.

The validity of both voter-initiated tax measures has been subject of litigation filed in the Superior Court for the City and County of San Francisco.  The actions claim that the initiatives cannot lawfully impose the special taxes because they received only a simple majority of the vote, in violation of the California Constitution’s requirement that taxes imposed by local governments receive a two-thirds supermajority.  The measures were also challenged under the San Francisco Charter.

On Friday, July 5, 2019, San Francisco Superior Court Judge Ethan P. Schulman upheld the validity of both initiatives, and determined that a simple majority of the vote was sufficient to support their passage.  The rulings are well summarized by the following comment from the order on the June 2018 measure:

the procedural two-thirds vote requirement . . . of the California Constitution that limit[s] the Board of Supervisors’ authority to impose new taxes does not apply to the voters’ initiative power, either directly under those provisions or indirectly under the San Francisco Charter.

The Court evaluated claims that the June 2018 measure was placed on the ballot by a member of the San Francisco Board of Supervisors in an effort to end-run the requirement of a supermajority vote.  The argument invited the Court to view the initiative as a legislative initiative rather than a voter initiative.  The Court rejected the arguments, based on a variety of earlier rulings regarding voter initiatives, including a 2017 decision by the California Supreme Court regarding an initiative that imposed licensing and inspection fees of medical marijuana dispensaries.  Similar analysis appears in the order regarding the November 2018 initiative.

Given the magnitude of the Court’s decisions, appeals are expected.

Coincidentally, the decision on the tax measures was issued on the same date on which the 2019 San Francisco Homeless Point-in-Time Count & Survey was released by the San Francisco Department of Homelessness and Supportive Housing.  The report concluded, that as of January 2019, there were over 8,000 homelessness people living in San Francisco, a 17% increase over the 2017 count, and a 14% increase between 2013 and 2019.”  It comments: “Unstable living conditions, poverty, housing scarcity, and many other issues often lead individuals to fall in and out of homelessness . . . [i.e.,] the experience of homelessness is part of a long and recurring history of housing instability.”  Although there has been suggestion that the survey actually undercounts the homeless population in San Francisco, there can be no question that homelessness is a problem that is getting worse.

There are myriad differences of opinion about how to address homelessness and other social ills facing San Francisco and other California jurisdictions.  However, the Court’s decision on the June 2018 and November 2018 tax measures will likely yield more efforts by state residents to tax the business community in an effort to fund possible solutions.

Commercial property owners should consider the financial risks associated with voter-initiated tax measures, and may wish to include provisions in their lease agreements that allow such special taxes to be passed through to commercial tenants as operating expenses.  As the characterization of such taxes continues to evolve – from payroll taxes, to gross receipts taxes, to commercial rent taxes – limited definitions of “operating expenses” may prevent property owners from recovering property-related expenses from commercial tenants, resulting in diminished property values.

Stay tuned.

 

Authored by Reuben, Junius & Rose, LLP Attorney, Corie Edwards

The issues discussed in this update are not intended to be legal advice and no attorney-client relationship is established with the recipient.  Readers should consult with legal counsel before relying on any of the information contained herein.  Reuben, Junius & Rose, LLP is a full service real estate law firm.  We specialize in land use, development and entitlement law.  We also provide a wide range of transactional services, including leasing, acquisitions and sales, formation of limited liability companies and other entities, lending/workout assistance, subdivision and condominium work.