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Some California entrepreneurs build businesses that include real estate as a core asset — retail locations, manufacturing facilities, office buildings, or investment property purchased by or for the business. California’s real estate legal and tax environment is distinctive enough that business owners who are experienced in real estate in other states, or who are new to commercial real estate entirely, can make costly mistakes by applying general knowledge without California-specific expertise.
Proposition 13 and Commercial Property
California’s Proposition 13, passed in 1978, caps property tax increases for existing owners at 2% per year from the most recent change of ownership. For long-term California property owners, this creates very low effective property tax rates relative to the property’s current market value — a significant financial benefit that has compounded over decades. For new purchasers, the property is reassessed to market value at the time of purchase, and property taxes reset to 1% of the purchase price (the constitutional base rate) plus any local special taxes and assessments. New owners pay full current-value property taxes while long-term neighbors with identical properties pay far less.
Change of Ownership Reassessment
California’s property tax reassessment rules for commercial property are complex and can produce unexpected reassessments even in transactions that don’t involve a simple sale. The change in ownership rules for entities — LLCs, corporations, and partnerships — can trigger reassessment when ownership interests change in ways that meet legal definitions of a change in control, even if the property itself doesn’t change hands. Business owners who transfer commercial property in connection with business reorganizations, entity formations, or ownership changes should get California property tax counsel before completing any transaction to understand whether a Proposition 13 reassessment will result.
Proposition 15 and the Split Roll
California voters narrowly rejected Proposition 15 in 2020, which would have required commercial property to be assessed at current market value rather than Proposition 13 values. Though defeated, Proposition 15 reflected a political appetite for commercial property tax reform that will likely produce future ballot initiatives. California commercial property owners should monitor this risk as an ongoing element of their California real estate investment analysis. A successful split-roll initiative could substantially increase property taxes on commercial properties held by long-term owners who currently benefit from Proposition 13 protection.
1031 Exchanges in California
California conforms to federal Section 1031 like-kind exchange rules, allowing California business owners to defer capital gains on the sale of investment real property by exchanging into other qualifying investment property. California requires taxpayers who complete a federal 1031 exchange to file California Form 3840 annually if they exchange out of California property into out-of-state property — tracking the deferred gain that California will tax when the replacement property is ultimately sold. California’s “clawback” provision for out-of-state 1031 exchanges is California-specific and can produce unexpected California tax on transactions that appear to have permanently deferred California gain.
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