SB 259, a bill that includes language to close the perceived loophole in the portion of Proposition 13 which governs “changes of ownership” in entities that own real property located in California, has been returned to the Secretary of the Senate and will not be moving forward.
California’s Proposition 13 (“Prop 13”) was famously passed in the 1970’s in an effort to protect property owners from dramatic rises in their annual property tax bills. It limits the ad valorem taxes on real property to 1% of the full cash value of the property at acquisition, with a 2% annual cap on assessment increases (consequently, a 2% annual increase has become pro forma in many California counties). Crucially, under Prop 13, real property may only be reassessed to its current fair market value if there is new construction or a “change of ownership” of either (a) the property itself or (b) the ownership interests in the entity that owns the property. Under Section 64(c) of the California Revenue and Taxation Code, there is a change of ownership when an entity or individual obtains control of “more than 50 percent” of the voting stock of a corporation or a “majority interest” in a partnership or LLC.
The application of that provision was at issue in Los Angeles County’s attempt to issue a fair market value reassessment to Michael Dell following his purchase of Ocean Avenue LLC (the owner of the Santa Monica Fairmont Hotel) in 2006.[1] In that transaction, Dell, his wife, and two of his investment entities purchased the ownership interests in Ocean Avenue LLC, each with no more than 49 percent control of the entity. Dell contended that pursuant to Sections 60 and 64 of the California R&T Code and 18 Cal. Admin. Code 462.180, because no individual or entity had gained control of more than 50% of the entity, there was no change of ownership in the property that the entity owned. Conversely, the Assessor contended that it was “too good to be true” that such a structure could avoid reassessment under Prop 13. The California Court of Appeal held—based on the plain language of Section 64 of the California Revenue and Tax Code—that there had been no change of ownership in the transaction, and it even ordered the County to pay Dell’s legal fees for asserting a “too good to be true” defense that was directly contradicted by plain statutory language.[2]
That background brings us to SB 259, which was one legislator’s attempt to close the perceived loophole that was at issue in Ocean Avenue. Specifically, SB 259 stated that a change of ownership occurs if 90 percent or more of a legal entity’s ownership interests are sold or transferred in a “single transaction,” even if no one person or entity acquires more than 50 percent of the entity’s ownership interest.
In that bill, a “single transaction” is defined as “a plan consisting of one or more sales or transfers of ownership interests that occur on or after January 1, 2016.” For this purpose, the bill created a rebuttable presumption that a sale or transfer is part of a “single transaction” if either (1) the transferees are persons described in Internal Revenue Code Section 267(b), or (2) the sales or transfers occur within a 36-month period, commencing on the date of the first sale or transfer of the ownership interests that occurs on or after January 1, 2016.
Internal Revenue Code Section 267(b) lists various relationships, including, but not limited to, members of a family; an individual and a corporation more than 50 percent in value of the outstanding stock of which is owned, directly or indirectly, by or for such individual; two corporations which are members of the same controlled group; a fiduciary of a trust and a corporation more than 50 percent in value of the outstanding stock of which is owned, directly or indirectly, by or for the trust or by or for a person who is a grantor of the trust; and a corporation and a partnership if the same persons own more than 50 percent in value of the outstanding stock of the corporation, and more than 50 percent of the capital interest, or the profits interest, in the partnership. Notably, the rebuttable presumption that a sale or transfer is part of a “single transaction” would have been triggered for Dell’s transaction if SB 259 were in effect at the time.
Commentary and Conclusion
SB 259 was, to say the least, a curiously indirect attempt to chip away at a perceived problem with the application of Prop 13 to transfers of ownership interests in entities that own California real property. In addition to its ambiguous terms (e.g., what constitutes a “plan” of sales under the bill?), the bill also appeared to do no more than replace one safe harbor with another. But the bill appears to be another attempt to reform Prop 13 that has died on the vine.
We will continue to track similar bills that attempt to address the perceived loophole in Prop 13 on the Alston Tax Blog and will be happy to discuss any issues related to California’s change of ownership provisions at any time.
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[1] Ocean Ave. LLC v. County of Los Angeles, 227 Cal.App.4th 334 (2014).
[2] Ocean Ave. LLC v. County of Los Angeles, No. B249722, 2015 WL 3990181 (Cal. Ct. App. July 1, 2015).
