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Corporations get big edge in Prop. 13 quirk

Sale of landmark Santa Monica hotel spotlights a legal loophole that costs the state tens of millions every year

May 05, 2013|Jason Felch and Jack Dolan
  • When Michael Dell bought the Fairmont Miramar Hotel in Santa Monica, his attorneys found him a way to save about a million dollars per year in property taxes.
When Michael Dell bought the Fairmont Miramar Hotel in Santa Monica, his… (Francine Orr, Los Angeles…)

In 2006, billionaire computer magnate Michael Dell, one of the world's richest men, agreed to pay $200 million for the Fairmont Miramar Hotel, a beachfront landmark in Santa Monica that long has been a retreat for Hollywood starlets and U.S. presidents.

A few months later, Dell tore up the contract.

For The Record
Los Angeles Times Tuesday, May 07, 2013 Home Edition Main News Part A Page 4 News Desk 2 inches; 87 words Type of Material: Correction
Proposition 13 loophole: An article in the May 5 Section A about a loophole in Proposition 13 that enables businesses to sidestep a tax reassessment examined the purchase of a Santa Monica hotel company by Michael Dell and partners. The article said Dell's lawyer cited state Revenue and Taxation Code Section 462.180(d)(s) in arguing that a husband and wife can split a property to avoid a change of ownership. The citation is from a section of the Board of Equalization's property tax rules, not the tax code.
For The Record
Los Angeles Times Sunday, May 12, 2013 Home Edition Main News Part A Page 4 News Desk 2 inches; 88 words Type of Material: Correction
Proposition 13 loophole: An article in the May 5 Section A about a loophole in Proposition 13 that enables businesses to sidestep a tax reassessment examined the purchase of a Santa Monica hotel company by Michael Dell and partners. The article said that Dell's lawyer cited state Revenue and Taxation Code Section 462.180(d)(s) in arguing that a husband and wife can split a property to avoid a change of ownership. The citation is from a section of the Board of Equalization's property tax rules, not the tax code.

He still wanted the hotel. But his attorneys had found a simple way to reshuffle the deal to avoid a legal change in ownership.

The maneuver saved about $1 million a year in property taxes -- an option available only to businesses, not homeowners, under the arcane rules governing Proposition 13.

The Miramar deal illustrates how businesses can easily -- and legally -- avoid property tax hikes under the California ballot initiative passed in 1978. As a result, the state loses tens of millions of dollars in revenue each year, officials estimate.

Voters overwhelmingly approved Proposition 13 out of a concern that homeowners, particularly the elderly, would be forced from their houses by rising tax bills during a real estate boom. The law ensured that property taxes were pegged at 1% of purchase price, assessed value could rise no more than 2% per year, and property was reassessed to full market value only when sold.

But large corporate property owners have been among the law's biggest beneficiaries, thanks in part to loopholes such as the one Dell used.

Essentially, the law allows businesses to sidestep reassessment if no one acquires a majority stake in a company that owns the property. Dell did that by bringing in his wife and two of his investment advisors as partners -- with no one taking more than 49% control of the hotel company. With no change in ownership, it continued to be taxed based on the 1999 property value of $86 million.

Los Angeles County assessors concluded it was a blatant tax dodge and raised taxes on the property.

A Superior Court judge disagreed, finding last December that the deal met the letter of the law. The county has filed an appeal.

Dell declined to comment. If he prevails, he will save more than $1 million a year, and taxpayers will probably also owe him more than $2 million in tax refunds and legal fees.

Christopher Thornberg, founder of research firm Beacon Economics and a former economist at UCLA Anderson Forecast, says the state has only itself to blame: "He didn't do anything wrong. He's saying to California: Look, idiots, I just robbed you blind, and it's your own fault."

Shifting tax burden

Passed 35 years ago by more than 65% of voters, Proposition 13 remains highly popular among property owners.

But during that period, the tax burden has steadily shifted from businesses to homeowners. In Los Angeles County, for instance, homeowners have gone from paying a 40% share of the total in 1975 to 57% today.

That shift is fueling efforts by some Democrats to tinker with Proposition 13. Eight separate measures were introduced this session. One, intended to close the loophole used by Dell, was recently tabled amid complaints by businesses that it was "a job killer." The others remain long shots.

Public support is growing, however, for a more sweeping change. A December poll by the Public Policy Institute of California found that 58% of likely voters favor a so-called split roll, in which commercial properties would be reassessed periodically regardless of their ownership.

The change would require a popular vote to amend Proposition 13, which is enshrined in the state Constitution, and would probably meet a wall of opposition from business owners, who complain they are overtaxed in California as it is.

For now, state and local officials are bound by rules that even some architects of Proposition 13 warned were ripe for abuse.

A year after Proposition 13 passed, state leaders began to grapple with the meaning of three words in the initiative: "change of ownership."

In the case of a single-family home, the change is obvious: A new deed is filed with the county recorder, triggering a reassessment. The property is then taxed based on its current market value.

But the transfer of business properties is more complex. What changes hands often is not the property but control of the legal entity -- a corporation, limited liability company or limited partnership -- that owns the real estate. In those cases, no new deed is filed.

A legislative task force searched for a bright line signaling a transfer and concluded that there were only two choices.

One was to require reassessment when a new company bought the property outright. The limitation of that was that it would capture too few transactions. The other method would require it when a single person or entity took control of more than 50% of a company that owned the property -- the majority-ownership rule.

Adopting the majority-ownership rule would lead to "monumental" enforcement problems, the task force warned: "No one, no matter how skilled and imaginative, can foresee ... every possible form of real property transfer."

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