Originally published on Forbes.com July 1st, 2014
The Court of Appeals of the State of California Second Appellate has given its blessing to a Superior Court decision approving billionaire Michael Dell’s avoidance of a reassessment from his acquisition of control of the Fairmont Miramar Hotel. The entity owning the hotel, Ocean Avenue LLC will be getting a refund of $314,680.95. There is also a claim for over a quarter million in attorneys fees.
Proposition 13
In a recent book , Confidence Games, on the raid on the treasury engineered by large accounting and law firms in the nineties and around the turn of the millennium, the authors cite Proposition 13 as the opening shot in the modern anti-tax crusade. Passed in 1978, the Proposition provided
…… real property may be taxed at no more than 1 percent of its ‘full cash value,’ with ‘full cash value’ defined to mean either the assessed value of that property in the 1975—1976 tax year or the property’s value at the time of a subsequent ‘change in ownership,’ subject to an adjustment for inflation. Thus, real property generally is taxed based on its value at the time of acquisition, not its current value.
Since that time, Proposition 13 has become something of a third rail in California politics.
The Technique
An entity, presumably controlled by Michael Dell, called 101 Wilshire LLC entered into a contract to buy the hotel from Ocean Avenue LLP (OA), which was owned by Hotel Equity Fund VII LP (HEF) in July 2006. In September 2006 that contract was torn up and HEF sold 100 % of its membership units in OA to:
The Susan Lieberman Dell Separate Property Trust acquired a 49 percent interest; MSD Portfolio, L.P.—Investments (MSD Portfolio) acquired a 42.5 percent interest; and Miramar Hotel, LLC (Hotel Investor LLC) acquired a 8.5 percent interest.
Michael Dell directly owns 99 percent of MSD Portfolio. The other 1 percent is owned by MSD Capital. Because Michael Dell owns 99 percent of MSD Capital, he directly or indirectly owns 99.9 percent of MSD Portfolio. There is no dispute that Michael Dell effectively owns 42.5 percent of Ocean Avenue through MSD Portfolio.
For federal income tax purposes, this would cause OA to be deemed to be terminated and reconstituted with new basis in all its assets. That is neither here nor there for property tax purposes under Proposition 13. Title to the property had not changed and though 100% of the owning entity had changed hands no person or entity ended up owning more than 50%.
There is a major renovation planned, which will trigger a reassessment then, but in the meantime, the hotel remains being taxed at its 1999 value.
The Decision
The assessors tried to attack the transaction on a couple of theories. One was that the contract for sale was in effect a transfer. Another was that Michael Dell[ really did end up with more than 50%. And then there is the substance over form argument. None of these went anywhere with the court.
According to the County, it “should be undisputed that Michael S.Dell has a majority interest in the capital of Ocean Avenue LLC.” As indicated by the numbers relied upon by the County, this argument fails. According to the County, Michael Dell[ owns 99.99 percent of the capital of MSD Portfolio, which owns 42.5 percent of Ocean Avenue. He owns 93.3333 percent of Blue Fin and Michelangelo, and those two entities, collectively, own 73.065 percent of Hotel nvestor, which owns 8.5 percent of Ocean Avenue. The flaw in the County’s argument is that it never does the math. The multiply-through test reveals the following: Michael Dell’s capital interest in Ocean Avenue through MSD Portfolio is 42.49575 percent, which is the sum of .9999 x 42.5. His interest in Ocean Avenue through Hotel Investor is derived by multiplying .933333 by 73.065, the sum of which is 68.194, and then by multiplying .68194 by 8.5, to reach 5.79649 percent. When 42.49575 percent is added to 5.79649 percent, the total is 48.29224 percent.
I didn’t check the math. I’ll leave that as an exercise for my most committed commenters.
On the substance over form argument, the answer was more or less that we are not in the United States Tax Court, Toto.
This argument lacks merit. First, this is a California property tax issue, not a federal income tax issue, which means that federal law is not controlling or even helpful. Second, the Board was bound by the property tax rules in the California Code of Regulations, so we cannot justify departing from those rules to uphold the Board’s decision. And third, the County failed to show that the sale of Ocean Avenue’s membership was the equivalent of a sale of the Hotel, i.e., an asset sale. Notably, general counsel for MSD Capital testified in front of the Board that a purchase of Ocean Avenue’s membership involved much more than a purchase of the Hotel. For example, it involved the acquisition of a pension liability as well as succession to liquor licenses and business permits.
Previous Coverage
The LA Times covered the transaction in May, but that was before the most recent appellate decision, which seems to have gone largely unremarked. Wayne Lusvardi in Fox and Hounds called the story an urban myth because if fails to distinguish between the sale of real estate and the sale of a business. It happens that there was a deemed sale of the real estate for income tax purposes along with the rest of the business assets, but that’s not property taxes. He also pointed out that in the long run, thanks to the massive renovation, there will be an increase in the property tax base. Of course, in the short run, there is that more than $300,000 refund.
There is also some indication that this transaction may have motivated the legislature to look at tweaking the Proposition 13 rules to address transactions like this. Particularly since there does not appear to be spousal attribution, it does look like it is a bit too easy to maneuver around reassessments.
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