Part 5:  Additional Rent – Taxes.

Substantially all the amounts that make up “Additional Rent” fall into three major categories: Taxes, Insurance, and Common Area Costs.  In this part we will focus in on Taxes.  In most commercial leases a landlord will want to pass through to each of its tenants their fair share of all the real property taxes and assessments that are billed by the local county assessor’s office against the legal parcel of land on which the tenant’s premises are located.

In a simple world, that total tax bill would be pro-rated between all the tenants located on that parcel based on a simple formula of multiplying the bill by a fraction for each tenant, the numerator of which being the square footage of the tenant’s parcel, and the denominator of which being the square footage of all the rentable space on that legal parcel.  However, because we live in California, and are subject to the real property tax rules of Proposition 13, other considerations fall into play.  As you may know, Proposition 13 generally limits the ability of the County Assessor to increase the assessed value of real property to no more than one to two percent per year, notwithstanding its fair market value, thereby limiting the amount your real property taxes can increase.

Generally, the only times the County Assessor can re-assess the value of a parcel to its fair market value, and tax it accordingly, are (1) upon any sale of the property, or (2) when substantial improvements are made to the property.  Since both of these factors generally fall within the control of the landlord, many tenants will want to limit any increase in their real property tax liability as a result of the landlord’s actions.  This is done by providing in the lease that the tenant will not be responsible for any increases as a result of a sale by landlord of the property, or as a result of any improvements to the property that are not specifically made to tenant’s premises, or that have no direct benefit to tenant’s premises.  Most landlords are reluctant to make any sort of concessions in this nature, except for an extremely strong tenant that brings value to its project, as such limitations on passing through the increased taxes to a tenant make it difficult for a landlord to sell or finance its property due to the lack of an income stream from Additional Rent to offset this additional tax cost.

In addition, commercial landlords have been concerned that certain political factions will someday succeed in eliminating the Prop 13 limitation on tax increases on commercial property through a “split role” proposition, or other means.  A “split role” proposition would keep the Prop 13 tax limitations in place for residential properties, but allow commercial properties to be reappraised on a more frequent basis than a sale of the property or substantial improvement to the property.  Alternatively, the same political factions may try an “end run” on Prop 13 by proposing a “rent tax” or other means of taxing income derived from commercial properties.  As a result, landlords have included very broad definitions of “Taxes” in their leases to cover themselves if such a situation occurs.

Other “gotchas” in a lease provision regarding Taxes would include a landlord’s desire to pass through any costs incurred by the landlord to oppose or contest any Taxes imposed against the property, whether or not the landlord is successful in such a contest.  A tenant may wish to limit its exposure by requiring that its only contribution to such costs would come from the tax savings realized by landlord being successful in its contest.

As to any “assessments” imposed against landlord’s real property by some governmental action, a tenant should require that to the extent landlord has the option to either pay the assessment in one “lump sum” or spread it over a term of years, that the landlord exercise the latter option so that if its lease expires before the allotted term of the assessment, the tenant will avoid having to contribute to such assessment for the years beyond its lease term.