A taxable possessory interest (PI) is created when a private party is granted the exclusive use of real property owned by a non-taxable entity. An expanded definition may be found in Revenue and Taxation (R&T) Code Sections 61, 62, 107-107.9, 480.6, and Property Tax Rules 20, 21, 22, 27, 28 and 29. In very simple terms, for a possessory interest to be taxable it must be independent, durable, and exclusive of the rights held by others.
Independent: The use must be independent of the public owner. That is, its holder may exercise authority and control of the property apart from the rules and regulations of the public owner.
Durable: There must be reasonably certain evidence to show that the possession will continue for a determinable period of time.
Exclusive: Its holder must be able to exclude others from interfering with the use of the property, (or, where there is concurrent use, the concurrent use does not significantly interfere with the holder’s use).
Taxable PIs can be created in virtually any use of government-owned real property. They are typically created when private individuals, companies or corporations lease, rent, or use federal, state or local government-owned facilities and/or land for their own benefit.
Examples of possessory interests include such things as:
The variety and form of such interests vary widely and evolve continually, and those listed above represent only a portion of the possible possessory interests that may be found.
California law exempts public agencies from paying taxes on the property they own, thus the lessee, who acquires the possessory interest, must pay property taxes on the possessory interest. The taxation of these interests is rooted in historical precedent. The California legislature first authorized the valuation of possessory interests for property tax purposes in 1859.
Those who receive possessory interest assessments are often puzzled by the seemingly unfairness of paying rent to a government entity while being asked to pay property taxes as well. However, government entities do not have to pay property tax and thus, their rent charges do not include an increment to recover such taxes (similar to a triple net lease).
At the same time, the private possessor still receives the services and benefits (fire and police protection, schools, and local government) that other similar taxable properties enjoy, and the possessory interest tax helps to pay the holder’s fair share of those costs.
The Assessor, by law, must search out and value all taxable property in the County as of the lien date, January 1, each year. This includes all taxable possessory interests. Annually, pursuant to Revenue and Taxation Code Section 480.6, Assessor’s staff requests every government agency in the County to provide various items of information such as leases and other agreements that are related to the real property they own. This information includes the name, mailing address, situs, lease amendments, assignments, new construction, etc., for each property. The Assessor analyzes this information when making the possessory interest assessments. It is important that the lessees keep this information current with their government landlords and that the agencies cooperate fully with the Assessor so that accurate assessments can be made by the County.
Base year values are established for taxable possessory interests upon change in ownership or completion of new construction under the guidelines of Proposition 13. The requirements for a change in ownership of a taxable possessory interest are found in Revenue and Taxation Code Section 61. A change in ownership occurs when a possessory interest is created, assigned, or upon expiration of the reasonably anticipated term of possession used by the Assessor.
The valuation of PIs differs significantly from other forms of property tax appraisal, as it is the appraiser’s job to value only those rights held by the private possessor. The appraiser must not include the value of any rights retained by the public owner or any rights that will revert back to the public owner (the “reversionary interest”) at the end of a reasonable term of possession.
Taxable PI values differ from real property unencumbered fee values in two ways:
As a result, PI assessments are normally and often significantly less than fee simple assessments of similar, privately owned property.
The determined base year value is protected by Proposition 13; it will only increase by a maximum of 2% per year, until a reappraisable event (change in ownership or new construction) occurs or the property suffers a decline in value (when sales prices or rents of similar properties decline, or the anticipated term of possession decreases – Proposition 8).
If a new base year value is necessary for the PI property, one or more of the income, comparative sales (or market), or cost approaches are used with certain modifications. These are more fully explained in Property Tax Rule 21.
Due to the principle of anticipation (the value of a property for a period of less than perpetuity is equal to the sum of its anticipated future income), the income approach is the most commonly relied upon method for valuing possessory interests. To estimate the PI value, the net economic rent and reasonably anticipated term of possession must be determined. The net income is capitalized and the resulting figure is the taxable value of the possessory interest.
Capitalizing the economic net income for the term of possession allows the Assessor to measure only those rights “possessed” by the tenant and exclude any non-taxable rights retained by the governmental landlord.
When relying on the income approach, the assessing appraiser must carefully determine three important factors:
If there are no rental payments, the appraiser must determine what the economic rent should be. If the actual rent is the economic rent, the appraiser may find the rent does not reflect all the rights in possession.
For example, it is not uncommon for holders of possessory interests to construct facilities on the leased property that will revert to the government owner when the lease expires. In that case, and presuming actual rent is economic rent, the valuation of the right using an income approach should reflect both the actual rent plus an imputed rent for the added improvements for the term of possession, or, the actual rent plus the value of the leasehold improvements built by the tenant.
A reasonably anticipated term of possession must also be estimated using such evidence as the actual contract or rental agreement itself, any history of prior use by the current tenant, or the history of another tenant’s use of the same or similar rights. In many cases the actual term of possession specified in the contract is also the reasonably anticipated term of possession.
For example, a tenant who has possessed a right for many years might have an actual month-to-month contract that does not reflect a term of possession anyone else renting the property could reasonably expect. In this case, the appraiser would research the government entity’s current policies, the prior history of the current tenant and/or the history of other past or current tenants to determine a reasonably anticipated term of possession.
If a PI tenant is actually under a long-term contract, the term of which is no longer reasonable due to economic conditions or obsolescence, the reasonably anticipated term of possession might be significantly less than the contract term.
In this approach to value, the sale of the subject property, or sales of other similar possessory interests reasonably close to the effective date of value, are used to determine the PI value. Contract rent paid on the property, and any other obligations assumed by the buyer, must be valued at its present worth and added to the sales price.
The taxable PI could also be valued indirectly by comparing the subject to sales of similar fee property. However, the present worth of the right of the government to take back the property at the end of the term of possession must be deducted from the value.
In the cost approach, the land value is estimated using the comparative sales or income approaches, less the present value of the reversion of the land to the lessor at the end of the anticipated term of possession. The reproducible property value (improvement value) is estimated by determining the replacement cost as new, less accrued depreciation, and less the present worth of the estimated value, if any, of such property at the termination of possession. The land and improvement values are then added together to arrive at a total value for the PI.
The types of interest being valued and the estimated reasonable term of possession will dictate which of the three valuation approaches to use.
Possessory interests are normally assessed on the Unsecured Tax Roll because the property rights being assessed are not owned by the assessee and cannot provide security for the taxes owed. In other words, the property cannot be used to satisfy any delinquent property tax.
Therefore, PIs are assessed as real property on the Unsecured Roll, but still fall under the umbrella of Proposition 13. That is to say, that although they appear on the Unsecured Roll, they are still assessed according to the laws pertaining to secured real property.
The payment schedule for Unsecured Roll tax bills is significantly different than for Secured Roll tax bills and taxpayers should be aware of that difference. Unsecured bills are due and payable in full no later than August 31, each year. If paid after August 31, a penalty of 10% plus costs will be added to the amount due. If not paid by November 1, additional charges begin each month thereafter. Unsecured bills are not split into two installments with two different delinquency dates, as is true of Secured Roll tax bills.