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California State Teachers' Retirement System v. County of Los Angeles

May 7, 2013

CALIFORNIA STATE TEACHERS' RETIREMENT SYSTEM, PLAINTIFF AND APPELLANT,
v.
COUNTY OF LOS ANGELES, DEFENDANT AND RESPONDENT.



APPEAL from a judgment of the Superior Court of Los Angeles County, Richard E. Rico, Judge. (Los Angeles County Super. Ct. No. BC389742)

The opinion of the court was delivered by: Klein, P. J.

CERTIFIED FOR PUBLICATION

Reversed and remanded with directions.

Plaintiff and appellant California State Teachers' Retirement System (STRS), a public entity, appeals a judgment following a grant of summary judgment in favor of defendant and respondent County of Los Angeles (the County) on a complaint for refund of property taxes.

STRS is authorized to invest in real estate. Because STRS is a unit of state government, property it owns is exempt from property taxation. (Cal. Const., art. XIII, § 3(a). However, the private lessees of real property owned by STRS are subject to property tax based on the lessees' possessory interest. The essential issue raised on appeal is the constitutionality of Government Code section 7510, subdivision (b)(1), insofar as it prescribes the method for determining the assessed value of a private lessee's leasehold interest in real property owned by a state public retirement system, when the lessee has leased only a portion of the property.*fn1

Section 7510, subdivision (b)(1) provides where, as here, a lessee has leased less than all of the property, the lessee's tax is based on "the lessee's allocable share of the full cash value of the property that would have been enrolled if the property had been subject to property tax upon acquisition by the state public retirement system," with the lessee's allocable share based on the lessee's percentage of the total leasable square feet of the property. (Ibid., italics added.) In other words, under the statute the lessee's tax is based on the full cash value of the property, even though the lessee holds only a possessory interest in the property.

We conclude there are two constitutional defects in the statute's valuation methodology. Section 7510, subdivision (b)(1), is facially unconstitutional insofar as it bases a lessee's assessment on the lessee's allocable share of the full cash value of the property, based on the lessee's percentage of the total leasable square feet of the property. Under the statute, the exempt remainder or reversionary interest, belonging to the public retirement system owner, is included in the assessment of the lessee's possessory interest. Consequently, the statute violates the prohibition against assessing property taxes on publicly owned real property (Cal. Const., art. XIII, §3(a)), as well as the prohibition on assessing property in excess of its fair market value. (Cal. Const., art. XIII, § 1.)

Therefore, the judgment will be reversed and the matter remanded for further proceedings.

FACTUAL AND PROCEDURAL BACKGROUND

1. The subject property and the assessment.

In 1984, STRS, a public retirement system, purchased the subject real property, an office building at 924 Westwood Boulevard in Los Angeles (hereafter, the building) for $28.5 million. The building has approximately 143,377 in net rentable square feet. STRS owns the building in fee simple.

Because STRS is a public entity, its interest in the building is exempt from property taxation. (Cal. Const., art. XIII, § 3(a).) However, a private lessee of publicly owned property is subject to property taxation on its "possessory interest" in the property. (§ 7510, subd. (b)(1).) Therefore, STRS's lessees in the building were subject to property tax.

In January 1998, Dong Eil Kim and Chang Nim Kim, doing business as Mail Boxes, Etc. (collectively, Kim) entered into a five-year lease with STRS for a retail space consisting of 1,280 square feet on the ground floor of the building. In a 2003 amendment to the lease, the parties extended the lease for an additional five years, to terminate February 4, 2008.

The original lease required Kim to pay, "[i]n addition to Base Rent, . . . Tenant's Proportionate Share of Operating Costs for each calendar year to compensate for changes in Landlord's Operating Costs." The original lease obligated Kim to pay all property taxes imposed in connection with the leasehold.

A 2003 amendment to Kim's lease provided: "5. Tenant shall continue to be responsible for its NNN charges under the lease, except that the real estate tax component shall be billed directly to Tenant, rather than as a percentage of total taxes paid for the building."*fn2

For the tax year July 1, 2006 through June 30, 2007, the County assessed the value of Kim's leasehold interest at $418,618. Based on the assessed value, the County levied a property tax against Kim in the amount of $4,983.34. STRS paid the County the amount of the tax owed by Kim.

2. Application for a reduced assessment and refund.

STRS and Kim then filed an application with the County's Assessment Appeals Board (Board) to reduce the assessed value of Kim's leasehold interest and for a refund. The application identified STRS as an "affected party" in the matter, and indicated the application was being presented as a "test case" to determine the appropriate valuation methodology for the various buildings STRS owns in Los Angeles County.

The application by STRS and Kim challenged the constitutionality of section 7510, and further argued that even assuming the statute were constitutional, its provisions had been misinterpreted and misapplied by the Assessor.

The Board denied the application. With respect to the constitutionality of the pertinent statute, the Board ruled that, as a quasi-judicial body, it lacked jurisdiction to declare the statute unconstitutional. The Board further found the Assessor did not misinterpret or misapply the provisions of section 7510, subdivision (b).

3. Trial court proceedings.

a. Pleadings.

On April 25, 2008, STRS and Kim (collectively, plaintiffs) filed a verified complaint for refund of property taxes. They alleged in pertinent part: "The valuation methodology that the County Assessor used in making this assessment was unsound and did not properly apply the governing provisions of the California Constitution, statutes, administrative regulations and assessment procedures in evaluating [Kim's] possessory interest under the Lease ('the Possessory Interest'). Among other things . . . , 'assessing property tax on the full fee interest in the property rather than just the leasehold interest in the property' results in a differential taxation of real property that violates Article XXX, Section I of the California Constitution because the value taxed is greater than the fair market value of the lessee's possessory interest alone."

The complaint sought a judicial determination that: (1) section 7510 is void and unenforceable in that it violates the provisions of articles XIII and XIIIA of the California Constitution; (2) the method of valuation used by the County Assessor and by the Board was unsound and resulted in an improper and arbitrary value for Kim's possessory interest in the premises; and (3) the common areas of the building do not constitute possessory interests subject to taxation because the common areas do not satisfy the requirements of possession, independence and exclusivity under the applicable law. Plaintiffs requested a refund of taxes paid and that the matter be remanded to the Board so that the County may value the possessory interest in a manner consistent with the trial court's determination.

b. Summary judgment papers; undisputed facts.

The County and STRS presented the case to the trial court by way of cross-motions for summary judgment. Kim was not a participant in the summary judgment proceedings. The papers reflect the pertinent facts are largely undisputed, to wit:

The County determined the base year value of the building based upon STRS's fee simple interest in the entire property. The base year was 1985 and the base year value was STRS's purchase price of $28.5 million. The County trended the base year value forward a maximum of two percent per year from 1985 to 2006, pursuant to Proposition 13 (Cal. Const., art. XIIIa, § 2(b)), and the cumulative upward adjustment from 1985 to 2006 was 48.642 percent. Thus, for the relevant tax year commencing July 1, 2006, the County assessed the value of the building at $42,362,834. Of that sum, the County allocated $29,744,119 to the office space and the remaining $12,618,715 to the retail space in the building. The County established Kim's percentage of the total retail rentable square footage by taking Kim's square footage and dividing it by the total retail rentable square footage. The County determined Kim's premises represented 3.317437 percent of the total retail rentable square footage. Applying that percentage to the $12,618,715 value of the retail space in the building, the County assessed the value of Kim's leasehold interest at $418,618. Based on the assessed value, the County levied property tax against Kim in the amount of $4,983.34.

In its moving papers, the County asserted section 7510 is lawful and valid.

STRS, in turn, argued the valuation methodology prescribed by section 7510, subdivision (b)(1), violates the California Constitution because: (1) it does not value taxable possessory interests in accordance with their fair market value; (2) it taxes property exempt from taxation; (3) its classification of taxpayers violates equal protection; and (4) its valuation methodology is not uniform in its application to all similarly situated taxpayers. STRS further contended the County violated the California Constitution in its application of section 7510, subdivision (b)(1) to Kim.

c. Trial court's ruling.

On January 14, 2010, the motions for summary judgment came on for hearing and were taken under submission. Thereafter, the trial court granted the County's motion for summary judgment and took STRS's motion off calendar as moot. The trial court ruled on the undisputed "facts and given the relevant case law, the statute on its face and the valuation methodology as ...


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