California Eminent Domain Report : a blog following condemnation, inverse condemnation, and regulatory takings written by attorneys with Nossaman LLP.

With the elimination of redevelopment agencies in California, we've been spending quite a bit of time lately discussing the impacts of Proposition 13 on California's budget woes as government agencies continue to fight over a slice of the shrinking property tax budget pie.  Proposition 13 has led to another interesting property valuation battle between county tax assessors and petroleum refineries, and the California Court of Appeal recently issued a published decision, Western States Petroleum Association v. State Board of Equalization, settling the dispute.

Prop 13 Background:  By way of background, Proposition 13 -- enacted in 1978 -- provides that real property taxes shall be based on the property's acquisition price (the "base year value"), and such amount cannot be increased more than 2 percent per year.  It essentially changed our real property tax system from one based on the current market value of the property to one based on the acquisition value of the property, plus an allowable increase over time.  Shortly thereafter, Proposition 8 was adopted to amend Prop 13 and make clear that if property values decline below the taxable indexed value, the taxable value may be adjusted down to reflect the property's fair market value.

Valuation of Land, Improvements & Fixtures:  In order to implement Prop 13, the State Board of Equalization (SBE) then adopted Rule 461, which provides that land and improvements shall constitute an appraisal unit, and fixtures, equipment and other improvements pertaining to the realty shall constitute a separate appraisal unit.  Ignoring our recent real estate recession, this valuation methodology created a perfect world for industrial property owners:  on the one hand, as property values continued to rapidly increase, property taxes were subject to the Prop 13 cap; on the other hand, as fixtures and equipment continue to depreciate over time, property taxes on these items had no floor.  Thus, industrial property owners could actually see their property taxes decline despite a surging real estate market.

The Litigation:  Not too happy with this valuation approach, in 2007 (the market peak), the SBE adopted Rule 474, which directed county tax assessors to start treating land, improvements, and all fixtures and equipment as a single appraisal unit for petroleum refineries.  This would, of course, mean that all the depreciation of the fixtures and equipment would be wiped out by the increasing property tax values (meaning refineries' property taxes would increase).  Petroleum refineries fought back and filed a lawsuit challenging the SBE's new regulation.

The trial court declared that the SBE's new regulation did not pass constitutional muster, as it violated Prop 13 and contradicted the SBE's own regulations.  On appeal, the Court agreed, holding that the SBE's proposed regulation would

allow for the adoption of new valuation formulas by which the framework governing real property could be manipulated to avoid the restrictions on real property taxes imposed by the voters when they approved Prop. 13 and Prop. 8.

So, petroleum refineries win.  This is good news for industrial property owners across the State; if the court had upheld this regulation, it's probably not much of a stretch to think the SBE might turn to other types of properties in another effort to collect more taxes.

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A new published California court of appeal decision may be important for private utility companies with respect to the valuation of their possessory interests in public rights-of-way for property tax assessment purposes.  The case, Charter Communications Properties v. County of San Luis Obispo, provides that when assessing the fair market value of a utility's possessory interest, the County tax assessor will likely be able to disregard the utility's agreed-upon remaining term of possession and instead assume a much longer anticipated term of possession to match reality.  This, in turn, means private utility companies should expect to see higher property tax assessments.  

Some background:  Under article 13, section 1 of the California Constitution, property is generally assessed as a percentage of its fair market value.  Private possessory uses of public property may also be assessed for property tax purposes.  With respect to private utilities in public rights-of-way, such possessory rights are typically valued by capitalizing the annual rent.  The annual rent is based on the franchise fee paid in exchange for the utility's possessory interest for (1) the remaining term or (2) the anticipated term.

The term of possession therefore becomes very important for valuation purposes, as the longer the term of possession, the greater the present value.  In the past, the assessor typically relied on the franchise agreement between the public entity and the private utility company in determining the remaining term.  As terms came closer to expiration, private utility companies were taxed less and less.  

The Charter Decision:  In Charter, the private utility company had between four and eight years remaining on its franchise agreements with the County for the placement of its television cables in public rights-of-way.  Instead of using this remaining term for valuation purposes, the County assessor instead valued the private utility's possessory interest by assuming a much longer anticipated term of possession (15 years).  

Charter challenged the assessor's valuation methodology, as it resulted in over half-a-million dollars of increased assessment.  Charter claimed there was no basis to deviate from the agreed-upon remaining term and assume a longer anticipated term of possession.  The trial court held that the assessor appropriately relied on an extended anticipated term as opposed to the parties' stated remaining term, concluding that the evidence demonstrated that these types of franchise agreements are routinely renewed indefinitely, and in fact Charter expected its cables to remain in-place indefinitely.

The Court of Appeal affirmed, also concluding it was appropriate for the County assessor to assume a much longer anticipated term for valuation purposes.  Despite the stated length remaining for its franchise term, there was no question that the utility provider would have its franchise renewed and the utilities would remain in place well into the future.  

Private utility companies will now need to seriously analyze their property tax bills and determine the valuation methodology employed by the assessor.  If the assessor deviated from the stated remaining franchise term, the utility provider will need to decide whether the deviation is supported.

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