Date of Hearing: April 1, 2019

ASSEMBLY COMMITTEE ON REVENUE AND TAXATION

Autumn R. Burke, Chairwoman

ABPCA Bill Id:AB 1453 (

Author:Chiu) – As Introduced Ver:February 22, 2019

FOR TESTIMONY ONLY

Majority vote. Fiscal committee.

SUBJECT: Property tax: welfare exemptions: rental housing and related facilities

SUMMARY: Expands the low-income rental housing property tax exemption for property owned by limited partnerships financed with both low-income housing tax credits and historic tax credits, as specified, and authorizes the refund and cancellation of taxes on such "low income historical housing" located in the City and County of San Francisco. Specifically, this bill:

1. Allows the welfare exemption to apply to low-income housing under the following criteria:
   1. The property owner is a limited partnership (LP) that master leases the property to a LP in which the managing general partner (MGP) is a S corporation^[1] wholly owned by an organization that qualifies as an Internal Revenue Code (IRC) Section 501(c)(3) exempt organization; and,
   2. The property is eligible for and receives both:
      1. Low-income housing tax credits (LIHTCs) pursuant to IRC Section 42; and,
      2. Historic tax credits (HTC) pursuant to IRC Section 47 relating to rehabilitation credits.
2. Commences the "low income historical housing" exemption for lien dates occurring on or after 2020.
3. Applies the low-income historical housing exemption retroactively for property located in the City and County of San Francisco (San Francisco).
4. Allows the refund and cancellation of property taxes in the case of low-income historical property located in San Francisco.
5. Cancels any outstanding ad valorem tax, interest, or penalty that was levied between January 1, 2010, and January 1, 2020, on low-income historical housing that that qualifies for the welfare exemption and satisfies the newly established criteria noted above.
6. Refunds to the taxpayer any tax, interest, or penalty paid before January 1, 2020 on low-income historical housing provided:
   1. The property owner files a refund claim with the San Francisco assessor, in the form and manner prescribed by the assessor; and,
   2. The property owner certifies that the property satisfied the criteria for low-income historical housing at the time the tax was levied.
7. Declares that this bill's refund and cancellation provisions are not a gift of public funds and that providing property tax relief for a housing development in San Francisco that provides decent, safe, and sanitary housing affordable to low-income households serves a public purpose.
8. Declares that the unique circumstances relating to properties financed with both federal LIHTCs and HTCs in San Francisco require a special statute and that a general statute cannot be made applicable.

EXISTING LAW:

1. Authorizes the Legislature to exempt from taxation, in whole or in part, property used exclusively for charitable purposes and owned and or held in trust by corporations or other entities: (i) that are organized and operated for charitable purposes; (ii) that are nonprofit; and, (iii) no part of whose net earnings inures to the benefit of any private shareholder or individual. (California Constitution Article XIII, Section 4(b).)
2. Implements this "welfare exemption" in R&TC Section 214.
3. Allows the exemption of low-income rental housing owned and operated by nonprofit organizations under the welfare exemption.
4. Allows the exemption of low-income rental housing owned and operated by a LP in which the MGP is an eligible nonprofit corporation or eligible limited liability company (LLC), as specified. (R&TC Section 214(g).)
5. Permits the LP to have a for-profit limited partner "owner." The for-profit entity serves to provide the equity necessary to construct or rehabilitate the rental housing by taking advantage of LIHTCs.
6. Requires the LP to have a MGP that is either an eligible nonprofit corporation or eligible LLC.
7. Lacks any provision to allow the MGP to be an S corporation that is wholly owned by an eligible nonprofit corporation.
8. Requires the MGP to obtain an organization clearance certificate (OCC) from the Board of Equalization (BOE). (R&TC Section 254.6.)
   1. Requires the MGP to have material participation in the control, management, and direction of the LP's business. (Property Tax Rule 140.1(a)(7).)^[2]
   2. Requires the MGP to have substantial management duties. (Rule 140.1(a)(10).)
   3. Requires the LP with a MGP to obtain a supplemental clearance certificate (SCC) from the BOE for each low-income housing property. (Rule 140.2(a).)^[3]
   4. Allows the BOE to grant a SCC to the LP only if the MGP already has an OCC. (Rule 140.2(b).)
9. Prohibits the assessor from approving a welfare exemption claim for a property until the claimant receives a BOE-issued OCC. (R&TC Section 254.5.)
10. Requires, for HTC eligibility purposes under federal law, property ownership by either the entity that utilizes the credit, or a master tenant that leases the entire building from the owner.
11. Lacks, under the welfare exemption, any provision specific to the financing of rehabilitation of historic buildings for low-income rental housing using HTCs.
12. Extends the welfare exemption to various properties that do not otherwise qualify under the general welfare exemption statute of R&TC Section 214 through a more specific statute. ^[4]

FISCAL EFFECT: Pending

COMMENTS:

1. The author has provided the following statement in support of this bill:

AB 1453 would restore the property tax welfare exemption for Kelly Cullen Community, a housing development of 172 units for chronically homeless individuals with on-site supportive services. For many years, the Kelly Cullen Community property received the welfare exemption; however, two years ago the county assessor determined that the property could not continue to receive the exemption because it involved a master lease, a structure that was required to obtain federal Historic Tax Credit used to renovate the building. The development provides low-income housing and is owned and operated by a non-profit, consistent with the welfare exemption and should continue to receive the exemption. This bill would allow the specific ownership structure, a master leased property that is a limited partnership that master leases the property to a limited partnership in which the managing general partner is an S corporation to qualify for the exemption. The welfare exemption is an important tool that allows the development to reduce the cost of the project and provide housing for chronically homeless individuals.

1. Committee Staff Comments:
   1. The welfare exemption: The California Constitution provides that all property is taxable, unless explicitly exempted by the Constitution or federal law.

In 1944, voters amended the California Constitution to allow the Legislature to establish a property tax exemption for property: (i) exclusively used for religious, hospital, or charitable purposes; (ii) owned by nonprofit entities organized and operated for charitable purposes; and, (iii) no part of whose net earnings inures to the benefit of any private shareholder or individual.^[5] This exemption is commonly known as the “welfare exemption”. In 1945, the Legislature enacted the exemption, providing that a qualifying nonprofit organization's property may be exempted fully or partially from property taxes, depending on how much of the property is used for qualified purposes and activities. (R&TC Section 214.)

In 1954, voters amended the Constitution to expand the umbrella of the welfare exemption to include buildings under construction and the land upon which they are situated if the building's intended use would qualify for the welfare exemption. Previously, the law required property to be in operational use before the exemption could commence.

Since then, the scope of the welfare exemption has been gradually expanded over the years.

• 1. The welfare exemption and low-income rental housing: The federal Tax Reform Act of 1986 created the Low Income Housing Tax Credit (LIHTC) program to provide incentives for private investment in housing for low-income families. Shortly thereafter, the Legislature authorized a state LIHTC to augment the federal LIHTC.

In 1988, California's welfare exemption eligibility applicable to low-income rental housing was significantly expanded^[6] to allow, among other things, low-income rental housing owned and operated by a LP in which the MGP is an eligible nonprofit corporation.^[7] This marked the first time an ownership structure involving a for-profit entity was permitted to qualify for the welfare exemption. To this day, this remains the only instance where for-profit entities are able to benefit from the welfare exemption.

Thus, low-income rental housing is unique in that while it is owned and operated by a LP that is not itself a nonprofit organization, the property may still be eligible for the welfare exemption if the MGP is an eligible nonprofit organization or eligible LLC with sufficient management authority and duties.

In 1999, the Legislature curtailed the exemption in this regard due to perceived abuses. Investigations into substandard rental housing revealed some properties benefiting from the property tax exemption under the prior welfare exemption expansion. Part of the reforms the Legislature undertook with the low-income housing exemption was to impose added oversight by requiring property owners to certify the existence of an enforceable and verifiable agreement with a public agency or a recorded deed restriction as to property use.^[8]

• 1. What does this bill do? This bill has two parts. First, this bill expands the welfare exemption for low-income rental housing to include a different kind of ownership structure when the housing project uses both LIHTCs and HTCs as funding sources. Specifically, when the property owner is a LP^[9] that master leases the property to another LP (the master tenant), the master tenant's MGP may be a for profit S corporation, but only if the S corporation is wholly owned by an IRC 501(c)(3) nonprofit organization. Current law requires a MGP to be either a nonprofit corporation or an eligible LLC. Second, this bill proposes to refund the property taxes paid on a project located in San Francisco that used this particular structure.
  2. Living at the YMCA: The Kelly Cullen Community (KCC) property is San Francisco's former YMCA, which was built in 1910 and located at 220 Golden Gate. The KCC is named in honor of Brother Kelly Cullen, a Franciscan friar who, in 1993, became the executive director of the Tenderloin Neighborhood Development Corporation (TNDC), a California Nonprofit Public Benefit Corporation organized for the charitable purpose of providing low-income affordable housing and related services in the Tenderloin area. Brother Cullen advocated for the homeless in the Tenderloin and died in 2010. The property is owned by a LP with a MGP (Turk Street Inc.) that is a nonprofit corporation and a TNDC affiliate. The TNDC is the property manager for the KCC property, which provides 172 efficiency studio units for formerly chronically homeless individuals and on-site social services for residents. The property also includes San Francisco's Department of Public Health Clinic, the Tom Waddell Urban Health Clinic, on the ground floor.
  3. First, a few technicalities: This bill, as currently drafted, does not align with the KCC property development details. First, a C corporation was created, rather than a S corporation. Second, while the KCC property was awarded LIHTCs, these credits were exchanged for another funding source as explained below. As such, the author intends to make corrective amendments.
  4. The financing structure: In 2007, the TNDC acquired the historic YMCA building, and began a lengthy process to raise the financing to rehabilitate and convert the building into a single room occupancy (SRO) project with supportive services for its residents. In December 2012, the project was completed. Project funding was obtained from various sources. Pertinent to this bill, both federal HTCs and the federal 2009 American Recovery and Reinvestment Act (ARRA) provided funding for the KCC property.

ARRA – Cash in lieu of LITCs (TCAP): Enacted in response to the Great Recession, ARRA was a federal stimulus program and represented a one-time opportunity to obtain lump sum funds for affordable housing projects.^[10] The California Tax Credit Allocation Committee (TCAC) had awarded the KCC project LIHTCs, but the credits were ultimately exchanged for the federal ARRA funds. Under ARRA, tax-credit recipients could, through TCAC, exchange the LIHTCs for a lump sum. Unlike the ARRA funds, LIHTCs are distributed over a number of years. In 2010, the TCAC awarded the KCC project federal ARRA funds, known as Tax Credit Assistance Program (TCAP) funds, in the amount of about $35 million.

Historic tax credits: Enacted by the federal Tax Reform Act of 1976, the Historic Tax Credit program encourages private sector investment in the rehabilitation and re-use of historic buildings. This federal tax credit allows program participants to claim 20% of eligible improvement expenses against their federal tax liability. The HTC program provides tax credits equal to 20% of qualified rehabilitation expenditures (QRE). QREs are the development expenses on which HTCs can be claimed. The KCC project received equity funding of $57 million through this program. The program requires that the equity investor acquire an interest in an entity that holds the property for rehabilitation, typically either a LP or LLC.

• 1. What is the problem? About two years ago, the county assessor discovered that the ownership structure of the KCC project involved a master lease, and the MGP of the master tenant is OCC ineligible because it is a C corporation, which is not organized as a nonprofit corporation. The LP property owner had entered into a master lease with a master tenant, another LP, to obtain HTCs. As a result, the assessor issued escape assessments (i.e., retroactive property taxes) for tax years 2013 through 2017 in excess of $2 million, which the owners have since paid. Annual ongoing property taxes on the property are about $500,000. The property manager indicates the retroactive taxes levied, in addition to the ongoing taxes, have created a serious financial burden on the KCC property as the project financing had relied on the property tax exemption to make it feasible.
  2. The managing general partner conundrum: In this case, the nonprofit corporation, which ordinarily directly serves as the MGP, instead created a for-profit corporation, that the nonprofit corporation wholly owns, to serve as the MGP. This different ownership structure was undertaken to allow the project to qualify for HTCs that, in turn, helped create the housing. This indirect non-profit MGP status has disqualified the KCC property from receiving the property tax exemption which this bill seeks to cure for low-income rental housing situated in a historically significant building.
  3. HTC rehabilitation properties in California: From 2002 through 2016, 169 projects received HTCs totaling $468 million in tax credits. This bill's refund and cancellation provisions would apply only to property in San Francisco. Since 2010, 10 properties in San Francisco received funding from HTCs. Committee staff is unaware whether any of these other nine properties might also include low-income rental housing that might be eligible for refunds.
  4. Refunds of property taxes paid: Typically, legislation to expand the welfare exemption to ineligible property due to some deficiency authorizes the cancellation of outstanding taxes not yet paid, but disallows the refund of taxes previously paid. On occasion, property tax refunds are retroactively permitted. In 2015, for instance, refunds were authorized on low-income housing projects denied the exemption in certain counties because of a payment in lieu of taxes (PILOT) agreement with a local government. The Committee may wish to consider whether refunds are appropriate in this situation.
  5. Dual welfare exemption administration: Both the BOE and county assessors administer the welfare exemption. Procedurally, the BOE first determines whether the owner is organized and operated for an exempt purpose and, if so, grants the owner an OCC.^[11] In the case of LPs owning and operating low-income housing, the BOE also determines whether the organization functioning as the LP's MGP has sufficient management authority. If so, the BOE grants the MGP an OCC, and grants the LP a supplemental clearance certificate (SCC).^[12]

Next, the assessor determines whether an organization's property use satisfies the welfare exemption requirements. The assessor makes this determination on its own, without BOE's review; but the assessor may not grant a claim unless the organization holds both a valid BOE-issued OCC and SCC (for the specific low-income housing property owned and operated by a LP with an eligible MGP). In the KCC property case, the BOE issued both an OCC and SCC to the original LP that has since master leased the property. The assessor in her administration of the welfare exemption subsequently discovered the subsequent master tenant/master lease arrangement the original LP entered into with another LP, which has an ineligible MGP.

• 1. Committee's tax expenditure policy: SB 1335 (Leno), Chapter 845, Statutes of 2014, added R&TC Section 41, which recognized that the Legislature should apply the same level of review used for government spending programs to tax credits introduced on or after January 1, 2015. This Committee has recently adopted a new policy, requiring that all new tax expenditure^[13] proposals comply with the requirements of R&TC Section 41. A tax expenditure proposal must outline specific goals, purposes, and objectives that the tax expenditure will achieve, along with detailed performance indicators for the Legislature to use when measuring whether the tax expenditure meets those stated goals, purposes, and objectives. In addition to the R&TC Section 41 requirements, this Committee's policy also requires that all tax expenditure proposals contain an appropriate sunset provision to be eligible for a vote.^[14] This bill contains a public purpose statement but it does not contain detailed performance indicators to measure whether the tax expenditure is meetings its intended purpose. Additionally, this bill does not contain a five-year sunset.
  2. Related legislation:
     1. AB 1326 (Gloria) would make permanent the expansion of the welfare exemption to units occupied by "over-income" tenants, that is up to 140% of AMI. AB 1326 is pending hearing by this Committee.
     2. AB 1734 (Chui) would expand the welfare exemption to include rental housing for moderate-income tenants. AB 1734 will be heard in this Committee on April 8.
     3. SB 294 (Hill) would increase to $250 million an exemption cap specific to non-government financed or non-LIHTCs low income rental housing properties. SB 294 also reduces the low-income occupancy threshold from 90% to 50% in these properties. SB 294 is pending hearing by the Senate Governance and Finance Committee.
  3. Prior legislation:
     1. SB 1203 (Jackson), Chapter 693, Statutes of 2015, authorized the refund and cancellation of property taxes paid prior to January 1, 2015 on certain low-income rental housing projects with a PILOT agreement with a local government.
     2. SB 314 (Vargas), of the 2011-12 Legislative Session, would have expanded the welfare exemption to the former Naval Training Center (now called “Liberty Station”) in San Diego, and its historic buildings were redeveloped into a civic, arts, and cultural center with New Market Tax Credits and Historic Tax Credits. SB 314 passage in this Committee.

REGISTERED SUPPORT / OPPOSITION:

Support

None on file

Opposition

None on file

Analysis Prepared by: Rose Marie Kinnee / REV. & TAX. / (916) 319-2098

1. Future amendments will instead refer to a C corporation. ↑

2. Property Tax Rule 140.1 "Requirements for Managing General Partner of Limited Partnership for Welfare Exemption for Low-Income Housing Properties." ↑

3. Property Tax Rule 140.2 "Requirements for Supplemental Clearance Certificate for Limited Partnerships for Welfare Exemption for Low-Income Housing Properties." ↑

4. For example, R&TC Section 237 relates to low-income rental housing owned by Native Indian tribes. ↑

5. California Constitution, Article XIII, Section (4)(b) adopted by the voters on November 7, 1944. Proposition 4 (1944) via ACA 17 from 1943. (Formerly Article XIII, Section 1(c).) ↑

6. AB 2144 (Filante), Chapter 1469, Statutes of 1987, added R&TC Section 214(g) to allow the welfare exemption apply in a LP beginning with the 1988-89 fiscal year. ↑

7. AB 3073 (Committee on Revenue & Taxation), Chapter 354 of the Statues of 2004, allowed eligible LLCs to qualify for the welfare exemption and allowed eligible LLCs to be a MGP. ↑

8. AB 1559 (Wiggins), Chapter 927, Statutes of 1999. Subsequent legislation has relaxed some of the initial constraints and controls enacted by AB 1559. ↑

9. The LP owner of the property has a MGP that is a nonprofit corporation, as current law requires. ↑

10. Between December 2007 and June 2009. ↑

11. R&TC Section 254.6(b). ↑

12. Property Tax Rule 140.2 (a) and (b) and Rule 140.1(e). ↑

13. A "tax expenditure measure" is defined as legislation meeting either of the following criteria: (1) the measure proposes to extend, expand, or enact a credit, deduction, exclusion, exemption, or other tax preference (i.e., a tax expenditure program); or, (2) the measure proposes to eliminate or reduce one or more tax rates. ↑

14. An "appropriate sunset provision" shall mean five years, except in the case of a tax expenditure measure providing relief to California veterans, in which case "appropriate sunset provision" shall mean 10 years. ↑