Real estate developers and commercial property owners have been gaming Proposition 13 since it was passed in 1978, amid concerns for people on fixed incomes losing their homes to an inflationary effect on their property tax bills.

The loophole, which allows commercial property to escape having its value reassessed when sold if none of the new owners has at least a 50% stake, didn’t get much publicity until around 2006 when computer billionaire Michael Dell bought the Fairmont Hotel in Santa Monica using the scheme and won a 2012 court case affirming his right to do it. Dell saves about $1 million a year on taxes because of Prop. 13.

Websites like Close the Loophole popped up and Democrats started talking about reworking the venerable initiative. But attempts at getting rid of the loophole went nowhere. Assembly Bill 188 introduced last January never got out of committee. It would have changed the law to exclude commercial real estate deals from Prop. 13 protection if 100% of the ownership interests are sold, regardless of whether any of the new ownership has a 50% share.

California Democrats passed a resolution (pdf) at their convention in April called “Close the Corporate Loophole,” in which they decried the “chronic budget crises” largely precipitated by Prop. 13.

And so, it was not that surprising to read in the Los Angeles Times Thursday that Brookfield Office Properties Inc. stood to save millions of dollars in property taxes on four skyscrapers the company is buying in downtown Los Angeles by structuring the $2.1 billion deal with Prop. 13 in mind. The official buyer will actually be DTL Holdings, a new company of which Brookfield owns just 47%. DTL, which also has other institutional investors, owns a bunch of other Brookfield downtown properties.

Frank Stoltze at KPCC said the original property assessment of $1.1 billion (about half the sale price) will be used to figure the tax liability, and save the company up to $10 million a year.

The loophole has had a dramatic effect on the funding of government. KPPC notes that commercial properties accounted for nearly half the tax burden in Los Angeles County in 1975. Now, it’s 30%, while the residential share has gone from 50% to 70%.  

The commercial property aspect of Prop. 13 differs from the residential in some significant ways. One of them is: What constitutes a change in ownership? When a house changes hands, a new deed is filed with the county recorder and a new assessment at current market value is triggered. Commercial property sales often don’t include a new deed; instead, it is control of the legal entity that owns the building that changes. No new deed, no new property assessment. No boost in tax liability.

A year after Prop. 13 passed, the Legislature recognized that it needed a mechanism that would bring commercial property transfers under its scope and opted for the 50% ownership rule. Corporations have been abusing it ever since.

Christopher Thornberg, founder of research firm Beacon Economics and a former economist at UCLA Anderson Forecast, explained to the Times in May why Dell and other big corporate owners are reaping millions of dollars from the loophole: “He didn't do anything wrong. He's saying to California: Look, idiots, I just robbed you blind, and it's your own fault.”       

The Brookfield deal is expected to close in a few weeks.

–Ken Broder

To Learn More:

Brookfield’s $2.1B LA Deal Raises Ire of Prop 13 Activists (by Frank Stoltze, KPCC)

L.A. Skyscraper Deal Raises Tax Questions (by Roger Vincent, Los Angeles Times)

35 Years after Prop. 13 Passage, Critics Decry Its Windfall Business Loophole (by Ken Broder, AllGov California)

System Failure: California’s Loophole-Ridden Commercial Property Tax (California Tax Reform Association)