California Proposition 13 and the 2020 Split-Roll Initiative: Weighing the Costs for the Commercial Property Market

By George King COVID19, Housing Policy, Real Estate

A Brief History of Proposition 13

In 1978, California voters passed an amendment to the Golden State’s constitution famously known as  Proposition 13.  Reining-in California’s then out-of-control property taxes, it established the concept of a base-year value for real property assessments, and limitations on tax rates and assessment increases thereafter.

Proposition 13 requires that taxes on residential, commercial, and industrial properties be limited to no more than 1% of the purchase price, with an annual adjustment equal to the rate of inflation or 2%, whichever is lower. Prior to Proposition 13, according to CaliforniaTaxData.com, local agencies independently established tax rates and assessed valuations with few limitations. The passing of Proposition 13 in 1978 has been credited with reducing California property taxes by more than 50%. 

Fast-forward to 2020, to a ballot initiative that could become a costly issue for California commercial property owners. The California Tax on Commercial and Industrial Properties for Education and Local Government Funding Initiative has qualified to appear on the November 3, 2020 ballot as an initiated constitutional amendment. If it passes, property taxes on commercial buildings could rise significantly due to the proposed modifications to Proposition 13.

The Evolution of the 2020 Ballot Initiative

The first version of the initiative (17-0055) qualified for the ballot on October 15, 2018. On August 13, 2019, the campaign Schools and Communities First announced that signatures would be collected for a revised version of the ballot initiative (19-0008) that further increased school funding allocation.  On October 17, 2019, the campaign was authorized by the state’s attorney general to begin gathering signatures for the revised initiative. On December 6, 2019, proponents announced that the number of collected signatures surpassed the 25% threshold required to initiate legislative hearings on the revised initiative no later than 131 days before the election. 

As of April 2, 2020, latest developments suggested revised ballot initiative 19-0008 may, in fact, be replacing previously qualified initiative 17-0055 on the November ballot.  And in order to be included on the ballot, the newer measure required 997,139 signatures to be validated.  It now appears though that over 1.7 million signatures were gathered ahead of the April 14, 2020 filing deadline.

It was later confirmed that on May 22, 2020, a random sample of signatures projected that 74.6% were valid. Based on that projection, the office of the California Secretary of State announced that the ballot initiative qualified to appear on the ballot at the general election.

The Impact for Commercial Property Owners

Both versions of the ballot initiative would amend the state constitution to require that commercial and industrial properties (except those zoned as commercial agriculture) be taxed based on their market value.  Notably, there is no distinction in the text that would indicate an exclusion of multifamily residential rental properties. Therefore, the presumption is that such properties will also be subject to the market-value reassessment.  And while commercial agriculture lands would be exempt from market value reassessment, fixtures and improvements would not – a potentially devasting blow to family farms.

The proposal to assess taxes on commercial and industrial properties at market value, while continuing to assess taxes on residential properties based on purchase price, is known as split-roll.  Nothing changes for the residential homeowner as Proposition 13 protections remain in place.  However, commercial property owners could see their property tax obligations skyrocket to more than double at the initial reassessment, followed by substantial increases through market value assessment adjustments every three years thereafter. 

For example, if a person paid $1 million for a commercial property in 1980, Proposition 13 allows a 1% property tax assessment on that purchase price – so a $10,000 tax bill.  Proposition 13 protections further limit any increase in assessed value to just 2% annually. Therefore, in 2020, that property is now assessed at around $2.2 million for property tax purposes, translating to a property tax obligation of roughly $22,000.

Now, if those Proposition 13 protections disappear for commercial property owners and that property is now subjected to reassessment at the current market value (say, hypothetically, around $6 million*), the property tax obligation jumps to $60,000 and you are now paying an extra $38,000 per year in taxes.  Moreover, if the Proposition 13 split-roll goes into effect and the taxation system changes, commercial property owners will have a reassessment every three years and will be taxed on the market value at that time.

It should be noted that there are some commercial properties that may not experience much of a change. For example, under initiative 17-0055, if a person owns and occupies a commercial property and the assessed value is under $2 million, they are exempt $3 million under the revised initiative. However, with California’s property values among the highest in the nation, this exemption likely counts for a relative few small-business exceptions – insignificant against the bigger picture.

Raising the Specter for Voters: Weighing the Costs in Light of COVID-19

Regardless if Initiative 19-0008 replaces Initiative 17-0055, a qualified split-roll measure appears destined to be included in the upcoming November ballot.  Opponents cite the measure as a no-win proposal, warning that the higher property taxes on businesses will also hurt farmers and raise the already-high cost of living for all Californians. Some further contend the measure is “catastrophically misguided” in the face of the economic impact of the coronavirus (COVID-19) pandemic which has thrown the commercial property market into chaos. It’s believed that, unless withdrawn, the measure would impede economic recovery and cause a mass exodus of businesses, taking countless jobs with them.  If left on the ballot, voters will be deciding on the largest property tax increase in state history against the backdrop of one of the largest economic crises in the country’s history. 

To say the split-roll initiative is a highly controversial matter is an understatement as there is no shortage of staunch support or passionate opposition.  Additionally, the unprecedented health and economic crisis brought about by the COVID-19 pandemic will likely work to galvanize positions for or against the initiative as both sides continue their efforts to persuade voters ahead of the November ballot.

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[1] CoreLogic’s Home Price Index for 2020Q1 shows that single-family home prices in California are up over 6x (6.87) from their 1980Q1 values. The illustrative example assumes that commercial properties have increased in value at a similar pace.