When is the sale of a building not a sale, at least for property tax reasons?
The question arose during last week’s heated discussion at the Zoning Adjustments Board over The Old Grove—the massive new housing-over-commercial project planned for University Avenue and Martin Luther King Jr. Way.
At one point during the discussion, Tom Hunt, a neighbor of the project, complained that the building would never be reassessed if sold in the future because it’s owned by a limited liability corporation (LLC).
If true, an LLC would be an effective tool for avoiding any future reassessments.
In an era when cash-starved local governments are laying off workers and cutting back services, cities and counties desperately need the increased revenues that come when property is reevaluated at the time of sale.
When a reporter posed the question of whether a LLC provides an escape from reassessment to a representative of the State Board of Equalization (BOE), the answer was: “Depends.”
The same question received different answers when posed to a leading tax attorney and the Alameda County Assessors office. All agreed, however, that the issue is far from simple.
Anita Gore of the BOE said the answer depends on the nature of the sale.
Citing the example of an LLC with five members each owning a 20 percent interest, she said the sale would trigger a reassessment if the property was sold to a single individual or if a legal entity making the purchase contained a member who owner more than 50 percent.
“But if the sale was five individuals who again owned equal shares, there would be no reassessment,” she said. “And it took an hour’s discussion with our experts to arrive at that answer.”
The LLC is a new creation historically, first enacted in Wyoming in 1977. It combines some of the features of a limited partnership with those of the corporation.
For an investor, it offers unique protections from legal liability. If an officer of a traditional corporation is found liable for personal misconduct in corporate affairs, he or she may incur personal liability. But an LLC officer sued for misconduct in corporate affairs cannot be held personally liable and the most a litigant can receive is a charging order against the LLC, a document the Los Angeles Business Club calls “virtually worthless.”
Berkeley’s best-known developers, Patrick Kennedy and David Teece, created LLCs to own each of their buildings that increasingly dominate the Berkeley landscape, and two of Kennedy’s former employees are doing the same for the massive two-building complex they plan at the site of Kragen Auto Parts on University Avenue.
Thus, there’s a Gaia Building LLC, a Fine Arts Building LLC, a Bachenheimer Building LLC and so on.
But a rising concern for local governments is just when does the sale of an LLC—or a significant change in ownership—amount to a transaction that would trigger a reassessment of property taxes.
“The law is quite bizarre,” said Lenny Goldberg, executive director of the Sacramento-based California Tax Reform Association. “It’s really more loophole than tax.”
Joseph G. De Angelis, a leading Sacramento County corporate and tax attorney, said that any time there is a change in corporate or LLC ownership of more than 50 percent, the new owners are legally obligated to report the change, triggering a reassessment.
Brian Hitomi, Chief of Appraisal Services for the Alameda County Assessor’s office, said any change in the percentages of ownership among LLC members would trigger reassessment.
“The owners are supposed to report,” said Hitomi, “and we are tracking percentages of ownership. But it’s based on self-reporting. Otherwise, there’s no way to know.”
Gore said reassessments definitely kick in when there’s a 100 percent change in ownership, “but if it’s less, the answer may be different.”
De Angelis cited the case of an LLC owned by three equal partners. Should one member sell out to another partner, the buyer would now own two-third’s of the corporation, theoretically triggering a reassessment. But should two partners buy out equal halves of the third owner’s interest, each of the owners would then hold exactly 50 percent of the LLC, not the “more than half” trigger that sets off a reassessment.
Goldberg cited a notorious Napa County case where one huge winery—Gallo—bought out another—Martini—with all its vineyards and buildings without triggering a reassessment.
“No one took more than 50 percent, so the entire sale of one large company to another took place with no change in ownership,” Goldberg said. “There are seminars for lawyers teaching them how to avoid reassessment.”
That’s not the only complication, said De Angelis. In the real world, ownership changes often go unreported. “As a practical matter, the county may not see it, although the state has now put a box on the LLC tax return that asks if there’s been a change in ownership.”
“We’re very reliant on the state informing us of changes of ownership,” said Hitomi of the county assessor’s office, “and there’s an effort going forward to seek these out more rigorously. The state is now looking for ownership changes throughout California so they can report to the counties.”
If unreported changes are found that should have triggered reassessments, an eight-year statute of limitations sets a cap on how much back taxes counties can collect.
The Legal Entity Ownership Program is a joint state effort by the Franchise Tax Board and the Board of Equalization, said Gore.
“The Franchise Tax Boards gets the information, and they trade information with the county assessors,” she explained. “We have a form we send out.”
De Angelis noted a second, structural reality that is also shifting the property tax burden onto homeowners and away from the business sector.
“If I sell a house, there’s no doubt it will be reassessed, and the typical California homeowner buys a new house every five to seven years,” he said. “But businesses sell far less frequently.”
So long as they remain under the same ownership, Proposition 13 limits business property assessments at the same 2 percent annual increase as residential property.
As a result, the homeowner share of property tax revenues has been inching steadily upward. In 1986, homeowners contributed 32.4 percent of state property tax revenues, compared to 38 percent 15 years later.
Two years ago, East Bay Assemblymember Loni Hancock authored legislation that would have mandated taxing at fair market value all nonresidential property not used for commercial agriculture.
The proposal drew massive opposition from Republicans, business and industrial groups, apartment owners’ associations, and lobbyists for commercial interests. Faced with the realization that the bill couldn’t pass, Hancock allowed it to die.
One bill now pending in the state senate would change the trigger mechanism for property tax reassessments. SB 17, by Sen. Martha Escutia (D-Montebello), would force a reevaluation whenever cumulative ownership changes of more than 50 percent occur.
That legislation has roused considerable opposition, in part because the bill would affect publicly traded corporations whose stock often changes hands with considerable frequency.
Goldberg—who worked closely with Loni Hancock on her failed legislation, said the change needed to happen constitutionally, just as Proposition 13—the source of most of local government’s current tax woes—occurred through a constitutional referendum.
“As it stands, the underlying law today is ludicrous,” he said.›