Prop. 13 'loophole' taken to state Supreme Court.

Prop. 13 |loophole' taken to state Supreme Court

Bank claims reassessment of |sale-leaseback' was illegal

In a high-stakes challenge to the local tax man, a Los Angeles landowner won approval July 19 to argue before the state Supreme Court that it may sell a 55-story building and then shield its buyers from a fate most California landowners never escape: revaluation by the local assessor, which typically triggers higher property taxes.

The property owner is Security Pacific National Bank, the largest bank in L.A. County, with $81 billion in assets. The contested property Security Pacific Plaza, the county's largest office highrise, boasts 1.46 million square feet of floor space.

At issue is whether county assessors may revalue "sale-leasebacks." In such deals, a seller leases back much of the property's space for his own use.

In 1984, Security Pacific sold the bank's headquarters tower for $310 million. The buyer, Metropolitan Life Insurance Co., signed over three-quarters of the floor space to Security Pacific under a long-term lease. Security Pacific never moved out and claims the transaction is not reappraisable.

If triumphant, Security Pacific would create a welcome precedent for real estate interests that do sale-leasebacks, saving them millions of dollars in taxes. The change, of course, would come at the expense of county governments, which rely on property-tax revenues.

Critics say the bank hopes to open a "loophole" to allow shrewd investors to escape Proposition 13's demand of automatic reappraisal after a sale.

What if Security Pacific prevails?

"It would be great for the owners of commercial office buildings," said attorney Tony Natsis, who specializes in commercial leasing law for Allen Matkins Leck Gamble & Mallory in downtown Los Angeles.

"This would give the developer one more device to avoid reappraisal," said real estate attorney Alexander Pope, of Barash & Hill in Century City.

Both attorneys, however, said the maneuver by itself is not a strong inducement to carry out a sale-leaseback.

Skirting reappraisal became economically attractive in the 1980s, thanks to steep appreciation of land prices. For example, when the Pasadena Hilton hotel sold in 1989, the assessor nearly quadrupled its tax-roll value, to $42 million. Its old assessed value dated back to 1975. The change meant $311,000 more in annual property taxes for the new hotel owner.

Following Security Pacific's building sale, the Los Angeles County Assessor's office revalued its highrise, based on the new price of $310 million, up from the $171 million then on the tax roll. Taxes, which are levied at 1 percent of assessed value, shot up by $1.6 million annually.

Under Metropolitan Life's pass-through arrangement, tenant Security Pacific pays the majority of the property taxes. Under protest, the bank has paid the higher bill, which has mounted to $10 million since the squabble began in 1985.

The bank points to language in state tax law that exempts from reassessment certain sales that reserve control to the seller for at least 35 years. The bank leased back most of its space for 60 years (including renewal options).

And, with potentially great significance, the bank made reference to its lease in the grant deed. The deed is the document conveying ownership to the life insurance company.

In court filings, the bank points to section 62(e) of the revenue and taxation code: "Change in ownership (which triggers reassessment under Proposition 13) shall not include: . . . Any transfer by an instrument (i.e. a grant deed) whose terms reserve to the transferor an estate for years . . ." A lease can be "an estate for years."

County attorneys were not impressed.

"We don't think that the mere insertion of a couple of sentences in the grant deed should result in a $10 million difference in taxes," said county defense attorney Albert Ramseyer. "Was Proposition 13 intended to focus on the substance of a transaction, or on the form, which in this case relies on the cleverness of the draftsman in drafting" the sale document?

Security Pacific's claims are illogical, said Ramseyer. While the bank tells the county assessor there was no change of ownership, it tells the reverse to Uncle Sam: The bank deducted rental payments on its IRS return.

Security Pacific and its attorney, Frederick A. Richman of O'Melveny & Myers, declined to comment on the case.

Oral arguments would not begin at the state Supreme Court for months, and a decision could be a year away.

Several real estate authorities said Security Pacific has a fair chance at victory.

The bank's case "has an underlying economic logic to it," said attorney Pope, himself L.A. County assessor from 1978 to 1986. Under his regime a bill was drawn up to short-circuit a gambit like Security Pacific's. The bill passed both houses in Sacramento but was vetoed by then-Gov. George Deukmejian.