Stuart Lieberman, a real estate attorney in New Jersey, once said the following about wording in a deed that allowed construction on open space designated land: “That’s not a loophole; it’s the Lincoln Tunnel.”
Lieberman made what appeared to be a loophole in a deed understandable through a concrete example. In the same way, the widely disseminated urban myth in California that there is a mysterious tax loophole in Proposition 13 for owners of commercial properties needs to be simply explained so that the public can understand that there is no such loophole.
A recent news article in the May 4 issue of the Los Angeles Times –- “Prop. 13 Loophole Gives Big Edge to Big Players” — continues to spread and compound the urban myth about a commercial property tax loophole in Proposition 13. Given the controversy over Proposition 13 protections for commercial properties, this so-called tax loophole is exploited for political purposes.
Prop. 13 provides for reassessment of property taxes only when a property is re-sold or substantially renovated. Before Prop 13 all property was annually reassessed depending on the ups and down of the market.
The L.A. Times story is about how billionaire Michael Dell –- of Dell Computers –- allegedly was able to exploit a tax loophole in Proposition 13 when he bought the Miramar Hotel in Santa Monica for $200 million in 2005. The failure of the media in reporting such commercial real estate transactions is that they don’t distinguish between a sale of the real estate and a sale of the business. They aren’t the same.
The Miramar Hotel was formerly called the Miramar Sheraton and managed by the Fairmont Hotels and Resorts chain. In 1999, the Los Angeles investment firm of Maritz, Wolff, and Company purchased the hotel for about $90.6 million from a company affiliated with Japan’s Fujita Corporation. Thereafter, the assessed value on the property for tax purposes was reportedly set at $86 million.
Before giving you the rest of the rather complicated details of this whopper urban myth allow this writer to provide an oversimplified example of the mistake that was made by the L.A. Times.
For Example
Imagine for a moment that your family runs a day care business out of a second home you own. Your family forms a corporation for the business to limit any liability in the event of a lawsuit. Your family pays personal income and corporate business income taxes on the business. And it pays and property taxes on the land and the building based on their highest and best use.
Your uncle loans you 49 percent of the money to start the day care center in return for a 49 percent share of the business. You own 42 percent of the business and your brother owns 8 percent. Your uncle’s name may appear on the deed to the property as a co-owner of the business but he doesn’t own the controlling interest in the property.
Later, your family sells the business to another party. The business value is based on the cash flow from the number of enrollments of children in the day care center, which does not affect the property value. Your family then leases the property to the new business operator on a short two-year lease until the new owner can “learn the ropes” of the business and renovate and expand the building improvements.
The first transaction does not necessarily trigger a property tax reassessment because it only involves the business not the real estate. This is because the business can be sold separately from the property. Businesses are transferred with a bill of sale and real property with a deed.
If the new tenant and business owner pulls building permits to substantially expand the day care center then that may trigger a property tax reassessment while the property is being leased.
But if the former single-family home usage of the dwelling was a higher and better use than a day care center then the County Assessor may not increase property taxes. Maybe you don’t care if the property would be assessed for a higher value as a home than as a day care center. This is because you need to run a business out of the home to have a job and income during the managed economic depression.
Now that you understand these elemental facts, let’s jump back to the Times story of how computer billionaire Michael Dell supposedly used a tax loophole granted under Proposition 13 to escape a property tax increase.
The Dell Deal
According to the Times, Michael Dell –- “one of the richest men in the world” – agreed to pay $200 million for the Fairmont Hotel in Santa Monica in 2005. A few months later the Times reports the “deal is reshuffled to avoid a change of ownership (of the property) by purchasing a non-majority interest in the company that owns the hotel. The Times reports this accurately. But the Times failed to distinguish that the sale of hotel business does not trigger automatic property tax reassessments. Government cannot force a business and the related real property to be sold together.
Dell forms a Limited Partnership called MSD Portfolio LP Investments. His wife buys a 49 percent interest in the business; Dell buys a 42.5 percent interest in the business; and the Miramar Hotel Limited Liability Company retains an 8.5 percent interest in the company. Reportedly, the Dell Partnership bought the Miramar Hotel business -– not the real estate — for $200 million. Such business deals are often not for cash and involve options, assumption of payment of existing taxes, and release of monies in the future when building plans are approved and an environmental impact report is certified.
Now comes the Times’ pea shell game of reporting. Keep your eyes on the business pea shell and the property pea shell.
The Times reports: “With no single entity owning more than 50 percent, the value of the hotel for tax purposes remains the same as the last time it sold, in 1999.” But the sale of the business had nothing to do with any change in value of the real estate unless they substantially upgraded the hotel facilities. So the story related in the Los Angeles Times has nothing to do with Proposition 13 because it wasn’t a real estate transaction. From 2005 to 2013, the Dells have been paying 88.5 percent of the corporate income taxes, hotel occupancy taxes, and personal income taxes, as well as the property taxes based on a 1999 tax reassessment.
The Dells are not escaping any property tax increase. In fact, the Dells will eventually end up increasing the property taxes by an estimated $4,240,000 per year instead of escaping $1,140,000 in property taxes as falsely reported by the Times (see table below).
Dell Deal Will Increase Property Tax Base
Not reported in the Times is that the Dell Partnership bought the 302-room ocean view hotel to redevelop it into a 265-room luxury hotel, new meeting facilities, retail space, a spa, and about 120 luxury condominiums. The existing parking for 167 cars would be upgraded to a 484-space underground parking garage. The proposed new development would include a 21-story Art Deco structure that will be the second tallest building in Santa Monica and become an architectural landmark for the city.
Of course, the Times also failed to report that Dell would build 40-affordable housing units on a hotel-owned parking lot across the street. Reportedly, only 12 affordable units would be required.
The Santa Monica Lookout Online reports: “An independent study estimated that the project will generate for the City approximately $5.1 million of net new property tax revenue per year at stabilization and $46.5 million in the first ten years of operation.” The Lookout further reports the new building project is estimated to cost $255 million.
The Santa Monica Dispatch Online reports the Miramar Hotel redevelopment project will create 150 new permanent Santa Monica jobs.
The amount of additional new hotel room taxes and business taxes that would be generated for the City of Santa Monica have not been estimated.
Wrong Spin
Contrary to the Los Angeles Times, there is no known Proposition 13 property tax loophole being exploited by Michael Dell’s purchase of the Miramar Hotel operating company. All the Dells are apparently doing is delaying a property tax reassessment until the redevelopment project pulls building permits as provided by law. Property taxes can’t be increased for something that is only proposed and unapproved.
And even if the property was reassessed in 2005 there is no guarantee that property taxes would have taken a 33 percent dip like other commercial properties after the Mortgage Meltdown and Bank Crash of 2008. Not reassessing the property tax in 2005 may very well have provided higher taxes than annually reassessing the property.
In return the proposed new project will generate $4.24 million in new property taxes and 150 permanent jobs that will remain union jobs. According to a Fiscal Impact Analysis by PKF Consulting completed for the City of Santa Monica, the project will also generate about $12,750,775 per year to the city during construction.
The Dell Miramar Hotel Redevelopment Project additionally proves that reinstating California’s redevelopment law is unnecessary to force property tax reassessment of older properties.
The Times’ spin on the Dell purchase of the Miramar Hotel business is that the super rich are escaping property taxes due to some mythological Proposition 13 tax loophole. The real story is that the super rich are increasing the tax base and creating new jobs for everyone’s benefit. And Proposition 13 probably saved the City of Santa Monica, Santa Monica School District, and County of Los Angeles from suffering an even worse decline in property taxes after 2008. That is because Prop. 13 has a built-in circuit breaker in it that prevents property taxes from free falling in an economic downturn.
The sale of the Miramar Hotel was not a tax loophole. It was 150 future permanent jobs, over $12 million per year to the City of Santa Monica during construction, over $5.1 million in annual property taxes for the City, and unestimated new hotel occupancy taxes, business taxes, and sales taxes from new retail development included in the new project. Paraphrasing Stuart Lieberman: “that’s not a tax loophole; that’s the NEW Miramar Hotel.”
Miramar Hotel Redevelopment
Breakdown of LA Times Versus Santa Monica Lookout Numbers
|
Business Value |
Real Property Value |
||
| Item: |
|
LA Times |
Santa Monica Lookout |
| Purchase Price 2005 |
$200,000,000 |
No property transaction |
N/A |
| Assessed Property Value based on 1999 sale |
N/A |
$86,000,000 |
N/A |
| Estimated Property Tax under Original $200 million |
N/A |
$2,000,000 per year |
N/A |
| Estimated Property Tax |
N/A |
$860,000 per year |
N/A |
| Estimated Tax Benefit to Dell |
N/A |
$1,140,000 per year |
N/A |
| Estimated New Assessed Value |
N/A |
Not reported |
$255,000,000
|
| Est. Increased Property Tax Revenues from Redevelopment |
N/A |
Not reported |
$4,600,000 to $5,100,000 per year |
| Net Property Tax Increase |
N/A |
Not reported |
$4,240,000 per year |
| New Jobs Created |
150 |
N/A |
N/A |
| New Affordable Housing Units |
N/A |
Not reported |
40 |
| Corporate Income Tax Increase |
Not estimated |
N/A |
N/A |
| Personal Income Tax Increase |
Not estimated |
N/A |
N/A |
| City Hotel and Business Tax Increases |
Not estimated |
N/A |
N/A |