Calculating Property Taxes for Tenancies in Common (TICs)
In San Francisco, tenancies-in-common have proliferated significantly in the last 15 years due to several factors; stringent land use regulations that discourages new developments and favors long-term tenancy, state law which allows rental buildings to be converted to owner-occupied use, the high cost of other forms of traditional housing, and the chance to convert a building to condos and experience a small financial windfall, among others.
The biggest disadvantage that TIC’s had relative to other forms of housing - shared mortgages - has effectively been eliminated with the creation of the fractional loan. However owners of TIC’s have and probably always will have a shared property tax bill. In concept the shared tax bill is relatively simple - all owners should pay their share of the total building tax tax that equates to their relative share of the overall property value. However two factors have complicated this relatively simple exercise:
- Significant delays by the Assessor-Recorder, sometimes up to three years, in re-assessing a property after a sale, and
- Mandatory tax impound accounts implemented by the biggest fractional lender in the market, Sterling Bank
Both factors combine to cause TIC owners stress and confusion about who owes what, and when - and that’s without the complications of how much of a deduction to take on a personal tax return given that the property tax year goes from July to June while income taxes are prepared for a calendar year.
Let’s look at the first problem, the delay in re-assessing a property after a transfer of interest. Here’s a simple example of the impact:
Assume a 3-unit building is converted to a TIC and sold to three owners, for simplicity all closing on July 1, 2015. The purchase prices are as follows:
Unit 1 $500,000 (25%)
Unit 2 $700,000 (35%)
Unit 3 $800,000 (40%)
Total Value $2,000,000
Also assume that the previous owner purchased the building 5 years earlier and the current assessed value is $1,000,000. The tax bill for the 2015-16 tax year will be based on the value of $1,000,000. Each owner would pay their relative percentage of the total bill. The building is not re-assessed in 2016-17 and 2017-18 but the value goes up by 2% (the maximum allowed under state law), to $1,020,000 and then $1,040,400. Again, the owners divide up the bill based on their relative percentages.
Then the property is re-assessed for 2018-19 to reflect the purchase prices. This triggers supplemental bills for the 2015-16, 2016-17 and 2017-18 tax years. Owners now have to come up with money to cover additional tax for three previous tax years, and they have to figure out how to divide it up.
To figure out the increase for each unit you’d have to know how the Assessor was valuing each unit when the building was assessed at $1,000,000, but as it is one parcel there were not separate assessments. Usually in this case the assessor divides the value equally and computes the supplemental tax based on the difference between the old value ($333,333 per unit) and the new values ($500K, $700K, and $800K).
This is obviously an overly simplistic example - it assumes the building sells on the first day of the new tax year and that all owners are still in place when the re-assessment happens. In real life things are much more complicated: people buy and sell throughout the year, requiring prorations for time as well as value. And sometimes people re-sell quickly, before the first re-assessment even takes place.
When things get this complicated the message to owners can and should be as simple and accurate as possible. The answer is this: pay property tax to a shared group account that is calculated using a) your purchase price (increased by 2% per year), b) the tax rate for that year, and c) the number of days you owned during that year. By doing that the group ensures that whenever the County re-assesses the property, the funds for supplemental bills will be in the shared group account when they come due. It also assures that an individual owner who sells before re-assesment isn’t able to escape their responsibility.
The second complication for property taxes is the Sterling tax impound account. Owners make monthly payments to Sterling for their share of tax, and then twice per year Sterling hands them a check, usually made out to the Tax Collector, to cover their share of the bill when it’s due.
One major inconvenience is that this requires tax bills to be paid with paper checks. Someone in the building has to collect Sterling checks, and write a check from the group account to cover owners who do not have Sterling loans, aggregate them all and mail or drop off the paper bill.
Another inconvenience is how federal law requires that they calculate the amount impounded, and this ties in with the confusion caused by delays in re-assesment. It generally works as follows:
Year 1: Sterling impounds tax based on the owners purchase price each month, and remits tax to the group based on the owners share of the current (low) tax bill. This results in an overage in the impound account.
End of Year 1: The bank is required by federal lending laws to reconcile the account at the end of the first year and refund overages directly to owners. The overage that is refunded belongs in the TIC group account to cover future supplemental bills, but often owners don’t realize this and they think the refund is theirs.
Year 2: Again as required by federal lending laws, Sterling adjusts the monthly impound to reflect the owner’s share of the current (low) tax bill. The monthly payment to Sterling drops and the owner is happy. Sterling remits checks to cover the owner’s share of the current (low) property tax bill.
Year 3: If the property has not been re-assessed, same as year 2. Owners continue to pay taxes at a rate that is too low, often without realizing it.
Year 4: The property is finally re-assessed. Sterling continues to continue to collect monthly impounds at the lower valuation and remits to little to cover the owner’s share of the new, higher bill (and has collected nothing to cover supplemental bills for prior years). This is usually the year where owners realize that Sterling’s impound accounts are not correct and that changes need to be made. Unfortunately that results in additional tax coming out of the owner’s pocket to cover both the supplemental bills and the additional amount owed in Year 4.
Year 5: Sterling adjusts the impound account to finally reflect the accurate assessed value.
As one can see, the impound account causes additional confusion that takes years to resolve because of the Assessor’s delay in re-assessing a property after a sale. And again, other units may change hands during this 4-5 year period, which starts the process all over again with a new owner.
To summarize, paying property tax for your unit in a TIC should be something that is easy and straightforward but is anything but because of how slow City Hall is and how poorly Sterling Bank manages tax impound accounts. Even if you don’t have a professional managing your TIC group account on a monthly basis, it is imperative to engage a professional throughout the process to ensure that owners understand what they actually owe in property tax and when it will come due.
The one simple rule is worth repeating: Plan to pay tax that is calculated based on your purchase price and the prevailing tax rate starting from day one of your ownership. Once owners understand that the rest is just bureaucratic inconvenience.