California split-roll initiative upsets solar developers

California split-roll initiative upsets solar developers

June 16, 2020 | By Keith Martin in Washington, DC and Sol Kwon in Washington, DC

A California “split-roll” ballot initiative would change the way commercial property is taxed in California and lead potentially to significantly higher property taxes on solar projects.

Property taxes would be assessed on commercial property at fair market value rather than on the historic cost as is the case under current law.

If the ballot initiative is successful, it is expected to increase annual property taxes by as much as $12 billion a year beginning in 2022. The change would be particularly troublesome for solar projects, effectively eliminating a long-standing property tax exclusion for solar systems.

The measure will be put to a vote this November.

Existing law

Under Proposition 13, real property in California is generally taxed at 1% of its 1975 value plus an adjustment for inflation, which is limited to 2% each year.

Real property is assessed at its current fair market value only when it undergoes a change in ownership or is newly constructed.

When improvements are made to an existing property, the fair market value of such “new construction” is added to the property’s assessed value.

Certain types of construction activity are excluded from assessment as “new construction.” In such cases, while improvements may increase the value of an existing property, the additional value is not subject to the property tax.

Proposition 7, approved by California voters in 1980, authorized an exclusion for active solar energy systems. The term “newly constructed” is defined in section 73 of the property tax statute to exclude “the construction or addition of any active solar energy system.”

The effect is to exclude new active solar energy systems from property tax assessment in California until a change in ownership occurs.

The solar exclusion applies to active solar energy systems placed in service before January 1, 2025. Any active solar energy system that was completed before 2025 will remain excluded until there is a subsequent change in ownership.

The solar exclusion has helped to drive the explosive growth of solar in California. California is the nation’s leader in solar power generation with more than 27,400 megawatts of generation.

Split-roll initiative

California Secretary of State Alex Padilla said on May 29 that the split-roll initiative became eligible for the November ballot with more than 1.09 million signatures.

If passed, the initiative will “split” how real property is taxed in California.

Residential property will continue to be taxed under the existing Proposition 13 rules.

Commercial and industrial property with a fair market value of more than $3 million will be assessed at its current fair market value and be reassessed at least once every three years. The new regime will generally not apply to commercial and industrial property with a fair market value of $3 million or less. However, if any of the direct or indirect owners of such property also owns an interest in other commercial or industrial property in California, the new regime will apply if all such property in the aggregate has a fair market value greater than $3 million. The $3 million threshold will be adjusted for inflation every two years starting on January 1, 2025.

If passed, the measure would take effect on January 1, 2022.

This change will essentially render the solar exclusion meaningless, since the concept of “new construction” will generally no longer be relevant when determining the assessed value of commercial property. Thus, most commercial, industrial and utility-scale solar power plants could become fully taxable on their current fair market values, despite the fact that many such projects are locked into long-term power purchase agreements under which the developers committed to supply electricity at prices that assumed no property taxes would have to be paid on the projects.

Advocates of the split-roll initiative say they did not intend to disturb the solar property tax exclusion, and they have offered to cooperate with the industry in an effort to remedy the situation. However, short of pulling the initiative from the November ballot and rewriting it in a manner that preserves the effects of the section 73 solar exclusion, there may be little that can be done to fix the problem.

Loss of exclusion

The impact to the industry of losing the section 73 property tax exclusion could be significant, particularly for operating plants and for unconstructed plants with signed power purchase agreements.

Virtually all operating solar power plants in California have long-term PPAs under which the projects have close to fixed revenue streams. These projects have limited ability to absorb unanticipated property taxes. In the worst case, some project companies could default on their debt and go bankrupt, while in the best case the equity value of the project would drop commensurately with the erosion in project cash flows.

An annual tax of 1% of the full value of a project after a 20-year life could mean that 20% of the project value would have to be paid in property taxes. This is on top of that revenue share that must go to pay income taxes.

Developers usually need a signed long-term power contract with fixed pricing to finance any new California project. They will have a hard time financing any project that is locked into a contract that was already signed and committed to sell electricity at prices that will be no longer economic.

Electricity prices will have to rise in order to absorb the higher property taxes for solar projects that no longer qualify for the exclusion.