Auerbach v. Assessment Appeals Bd. No. 1

Decision Date11 May 2005
Docket NumberNo. B173649.,B173649.
CourtCalifornia Court of Appeals Court of Appeals
PartiesRick AUERBACH, as Assessor, etc., Plaintiff and Appellant, v. ASSESSMENT APPEALS BOARD NO. 1 FOR the COUNTY OF LOS ANGELES, Defendant and Respondent; Northern Trust Bank of California, as Trustee, etc., Real Party in Interest and Respondent.

Raymond G. Fortner, Jr., County Counsel, Albert Ramseyer, Principal Deputy County Counsel, for Plaintiff and Appellant.

No appearance for Defendant and Respondent.

Rodi, Pollock, Pettker, Galbraith & Cahill, Cris K. O'Neall and Wade E. Norwood, Los Angeles, for Real Party in Interest and Respondent.

MALLANO, Acting P.J.

Rick Auerbach, the Los Angeles County Assessor (Assessor), appeals from a judgment denying his petition for a writ of mandate seeking to reverse the decision of Los Angeles County Assessment Appeals Board No. 1 (Board) reassessing commercial real property subject to a 20-year lease (Property) and applying the $1 million grandparent-grandchild exclusion from assessment under Revenue and Taxation Code section 63.1.

Both the Board and the trial court determined that the lessee was the "owner" of the improvements which it had constructed on the Property and that a grandparent-to-grandchild transfer of the lessors' interest in the Property transferred only the land and not the improvements and thus concluded that the Assessor erred in including the improvements in the calculation of the exclusion. We disagree and reverse the judgment because, notwithstanding the lessee's construction of the improvements, both the land and the improvements are subject to, and included in the calculation of, the grandparent-to-grandchild exclusion.

BACKGROUND

Real party in interest Northern Bank of California (Trustee) is the cotrustee of two trusts which together hold a 50 percent interest in the Property, located on North Rodeo Drive in Beverly Hills. In 1999, the Property was valued at about $21 million, with the land valued at about $9.5 million and the improvements, a two-story retail building, valued at about $11.5 million. Robert and Electra Anderson, the grandchildren of Stanley and Marguerite Anderson, are each a beneficiary of one of the two trusts.

In February 1996, the two trusts, with two other trusts not involved in this action, entered into a lease agreement (Lease) by which the trusts leased the Property to Tommy Hilfiger Retail, Inc. (Hilfiger) for an initial term of ten years, with two five-year options to extend the Lease. In 1996, the Property was improved with a 14,400-square-foot retail building, which was occupied by another tenant.

The Lease provisions required Hilfiger either to renovate the existing building with a minimum expenditure of $2 million or to demolish it and build a new one with a minimum expenditure of $4 million. Hilfiger took possession under the Lease and elected to demolish the existing building and to build a new one, which it completed and occupied in about November 1997. Hilfiger's parent company paid about $20 million in cash to construct the new building.

A Lease provision captioned "Ownership" stated that "[d]uring the term of this Lease, the Improvements shall be the property of and owned by Lessee but considered a part of the Premises. The Improvements shall, at the expiration or earlier termination of this Lease, become the property of Lessor and remain upon and be surrendered by Lessee with the Premises."

The Lease further stated: "Lessor acknowledges Lessee's intention to construct a `Flagship' location which may require extensive changes to the building storefront and Lessor agrees to cooperate. However, Lessor expressly prohibits Lessee from taking any action that would reduce the square footage of the building footprint or would reduce the frontage of the building facing Rodeo Drive or facing Santa Monica Boulevard. Lessor will have the right to approve any plans but will be reasonable in allowing Lessee to create and sign this building to its requirements."

The Lease provided that "Lessor and Lessee acknowledge and agree that as a material inducement to Lessee to enter into this Lease, Lessor has agreed that its consent to the Improvements (as hereinafter defined) shall be liberally granted even in the event that Lessee's plans and specifications call for the razing and rebuilding of the Premises or dividing the Premises into separate units; and Lessor and Lessee further acknowledge and agree that as a material inducement to Lessor to enter into this Lease, Lessee has agreed to either, at Lessee's option, substantially renovate the building on the Premises and the Premises in general . . . or to raze and completely rebuild a new building on the Premises. . . ."

The Lease also required the lessors' consent for Hilfiger to mortgage or encumber the improvements, to assign or transfer the leasehold, and lessors' approval of any architectural plans, alterations, or construction of new improvements. And although the Lease required Hilfiger to pay the real property taxes, the lessors were required to pay any increase in real property taxes due to, or resulting from, the sale of the Property. In the event of partial damage or total destruction of the property, Hilfiger was required, at its expense, to repair such damage, but if the damage was an insured loss, the lessors were required to make any insurance proceeds available to Hilfiger for purposes of repair.

On June 16, 1999, John Anderson, the father of Robert and Electra Anderson, died. Under the terms of the trusts, John Anderson's death resulted in a transfer of the grandparents' interests in the Property to the grandchildren. The grandchildren, through the Trustee, applied for a grandparent-grandchild exclusion (exclusion) pursuant to Revenue and Taxation Code section 63.1.1 In December 2001, the Assessor's office granted the exclusion. The Assessor applied the $1 million exclusion to the land and the improvements, allocating approximately 8 percent of the exclusion to the land and 92 percent of the exclusion to the improvements on a pro rata basis. The Trustee filed an application with the Board, contesting the Assessor's calculation of the exclusion.2 The Trustee contended that the exclusion should have been applied only to the land, arguing that the grandchildren did not have a "present beneficial ownership" interest in the improvements constructed by Hilfiger.

A hearing on the Trustee's application was held before the Board. Henry Pramov, Jr., an attorney, testified for the Trustee. Pramov had a general business practice with an emphasis in real estate law, but he had no expertise in property tax law. Pramov represented the trusts in negotiating the Lease. According to Pramov, the provision of the Lease providing that Hilfiger was the owner of the improvements during the Lease term was for tax purposes and so that Hilfiger would be able to depreciate the improvements over the term of the Lease. The Lease contained larger rent concessions or reductions for year three of the Lease term if Hilfiger chose to rebuild rather than renovate the improvements on the Property. The consideration to the trusts for the rent reductions was that the trusts would eventually own the improvements upon the expiration or termination of the Lease. In an economic sense, the transaction was equivalent to a commercial lease in that the trusts "have the benefit of rental payments for their land during the term of the lease and then the benefit of having the improvements revert to them in the end." According to Pramov, the improvements in this case had a life of 20 years or more. Pramov also testified that if the trusts had undertaken the cost of the improvements, the rent exacted from Hilfiger would have been higher, but because Hilfiger paid for the improvements, the rent paid by Hilfiger was essentially "ground rent." The trusts received the property tax bills, but sent them to Hilfiger. Hilfiger paid the property taxes.

Pramov noted that the Lease did not contain any provision allocating the rent between the land and the improvements, but testified that the rent paid under the Lease was not for the improvements but for the use of the land. According to Pramov, the trusts had a "remainder interest" or a "springing interest" in the improvements that would "come into play when the lease terminates," but the trusts had no ownership interest in the improvements in June 1999.

Steven Brown, an employee in the Assessor's office, testifying for the Assessor, stated that the property tax bill for the Property was sent out in the name of the record owners of the land, the trusts. For purposes of the Lease, Hilfiger may have "owned" the building, but not for property tax purposes. For property tax purposes, the trusts were the primary owners of the Property because the Lease term was less than 35 years. And the trusts had present beneficial interests in the Property represented by the rent received and the expectation of the reversion of the improvements upon the termination of the Lease.

In April 2003, the Board issued its decision determining that on the June 16, 1999 transfer date, there was no change in ownership of the improvements, which were owned by Hilfiger. The grandchildren did not have a "present beneficial ownership" interest in the improvements within the meaning of section 63.1 because of the "Ownership" and other provisions of the Lease and because Hilfiger paid the costs of the new improvements. The Board determined that the grandchildren held a "non-possessory future remainder interest in the improvements; this was not a `present' interest that benefited the Grandchildren. In addition, to the extent that this future interest was transferred, such transfer was not a change of ownership." The Board thus concluded that the exclusion should have been applied only to the land and not to the improvements constructed by...

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