News Column

Calif.'s Prop. 13 Loophole Gives Big Players an Edge

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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.

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."

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."

But the Legislature adopted it anyway, concluding it was the better of two imperfect solutions.

Today, the Board of Equalization relies on businesses to accurately disclose changes in majority ownership. Assessors sometimes scan newspapers for big deals the board might have missed.

Often, buyers take majority ownership because other business advantages outweigh the tax benefit.

But the Miramar deal is not the only instance in which a wealthy buyer has used the majority-ownership loophole to save millions.

In 2002, E&J Gallo, the world's biggest winemaker, purchased Louis M. Martini, which owned more than 1,000 acres of prime Napa and Sonoma County vineyards. None of the property was reassessed because Martini was divided among 12 Gallo family members, none of whom acquired more than 50%.

Some of that property today is worth more than $150,000 an acre but continues to be taxed based on its 1975 value of a few thousand dollars an acre, according to Napa County assessor John Tuteur.

In 1998, a Canadian skiing conglomerate bought 58% of Mammoth Mountain resort, which had been family-owned for years. The new owner, Intrawest Corp., argued that the property should not be reassessed because the deal did not give it a majority of the voting rights in the company.

The county assessor concluded that challenging the ski resort in court would be too costly.

In 2005, it changed hands again. This time, the buyer bought majority control and paid for it in property taxes: The assessed value almost doubled, bringing in an additional $1 million in annual revenue for Mono County.

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At the time Dell bid for the Miramar hotel with its 10-story tower and poolside bungalows, Forbes listed him as the 12th-wealthiest person in the world. His fortune was estimated at $17 billion.

He had never been a fan of property taxes. In the 1990s, Dell had a protracted fight with the city of Austin over the value of his 22,000-square-foot mansion. The county appraised its value at $22.5 million, but Dell appealed, arguing it was worth $6 million at most. Eventually the two sides settled upon a value of $12 million.

In 2006, Dell reduced the annual tax bill on his Texas ranch from $580,000 to $1,300 by qualifying for a wildlife exemption, which required him to feed wild turkeys and hunt white-tailed deer on the 1,700-acre property outside Austin.

He bid that same year for the Santa Monica hotel.

After discarding the first contract, Dell arranged for three partners to buy Ocean Avenue LLC, the holding company that owned the hotel. A firm owned by Dell acquired 42.5%. His wife Susan's trust acquired 49%. And a company set up by two of Dell's investment managers acquired the remaining 8.5%.

Dell reported to state tax officials that there had been no change in ownership. The Los Angeles County assessor's office learned about the deal after reading about it in The Times.

Staff members asked a lawyer at the Board of Equalization whether they could consider the deal a change in ownership. When the answer was no, the county decided to reassess anyway and raised the hotel's taxes.

In a hearing before the Assessment Appeals board, county counsel Albert Ramseyer argued that the Dells plainly took control of the property from the seller. He urged the board to "use common sense."

Dell lawyer Christopher Matarese responded that common sense is not the standard. He pointed to Revenue and Taxation Code section 462.180(d)(s), which says that a husband and wife can acquire 100% control of a property with no change of ownership as long as they split it 50-50.

"This court should not undo almost 40 years of change in ownership legislation because the assessor thinks the law is 'too good to be true,'" argued Matarese.

In December 2010, the Assessment Appeals Board ruled for the county, concluding Dell retained "ultimate control" of the hotel and had concocted the partnership to avoid reassessment.

Dell took the county to Superior Court. Five months ago, Judge Joanne B. O'Donnell struck down each of the assessor's arguments and ordered the county to refund his taxes and pay Dell's legal fees.

As Los Angeles County pursues its appeal, Dell's team has announced new plans for the Miramar: a massive remodel that would add a 21-story tower, making it Santa Monica's second-tallest building.

Local activists flooded a recent City Council meeting to object, saying it would turn Santa Monica into Miami Beach.

To bring neighbors around, Dell's team has touted the economic benefits of the plan, saying it would "generate important new revenue for Santa Monica ... money that will support our police, fire, schools and parks."

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