Background on Prop. 15: On November 3, 2020, California voters will decide whether to adopt the “Split Roll” Initiative, Prop. 15. If passed, many commercial and industrial properties would lose “Prop. 13 protection,” and would be re-assessed and taxed based upon market value. Residential and agricultural properties would notlose “Prop. 13 protection.”
Commercial properties can be reassessed as early as the 2022-23 fiscal tax year, as discussed in California’s Controversial “Split Roll” Initiative (Prop. 15): The Basics.
Question: Should Brokers Add “Prop. 15 Protection” to LOIs?
Answer: Leases entered into in 2020 will likely require tenants to pay any Prop. 15 tax increases. A tenant’s broker should review the Prop. 15 risk considerations discussed below, and evaluate whether to negotiate for “Prop. 15 protection,” or to advise the tenant of the risk.
Landlord Considerations:Landlords are not as concerned about incorporating Prop. 15 provisions into their LOIs (or leases). AIR CRE Leases generally require Lessee to pay increases in property taxes, regardless of the cause of the increase, except for one rarely-used AIR CRE Lease. (For more detail, see Will Tenants Pay the Increased Property Taxes?).
Risk Considerations For Tenants: Tenants and their brokers should consider the following factors in assessing Prop. 15 risk:
- Is the Property Subject to the $3MM Exemption?: If a property has a market value of $3,000,000 or less, it may be exempt from re-assessment under Prop. 15. (For details on this exemption, see Prop 15’s $3MM Exemption).
- What is the Property’s Current Tax Basis?: What is the tax basis of the property versus the current market value? If the property was recently sold, the tax basis may be relatively close to the current market value. If Prop. 15 passes, when the property is assessed based upon market value, there may be less risk of a dramatic property tax increase.
- Is the Property 50% or More Occupied By QualifyingSmall Businesses? If a property is 50% or more occupied by qualifyingsmall businesses, it would not be reassessed until at least the 2025-26 fiscal tax year. A business qualifies as a small business only if: (1) it has fewer than 50 annual full-time equivalent employees; (2) it is independently owned and operated; and (3) it ownsreal property in California.
- Is the Property Subject to Re-Assessment as Early as the 2022-23 Fiscal Tax Year?: If Prop. 15 exceptions do not apply, the property could be reassessed as early as the 2022-23 fiscal tax year and the re-assessments would be phased-in over multiple years. The longer the term of the lease (or lease renewal) extends into the period when the property can be re-assessed, the higher the potential property tax exposure to the tenant.