On April 12, 2024, the United States Supreme Court issued an opinion that may significantly affect how development impact fees are assessed in California. In Sheetz v. County of El Dorado,[1] the Court unanimously held that legislatively imposed permit conditions are subject to the same constitutional test – informally referred to as the “Nollan/Dolan” test – as administratively adopted permit conditions. Under this test, permit conditions must have “an essential nexus” to the government’s land use interest and a “rough proportionality” to the development’s impact on the land use interest.

Prior to Sheetz, when a local government imposed an exaction through legislative action (such as development impact fees adopted and imposed under the Mitigation Fee Act), it did not need to satisfy the tests established under Nollan v. California Coastal Commission[2] and Dolan v. City of Tigard.[3] As a practical matter, this meant that legislatively adopted fees received very little scrutiny when applicants challenged them in court. Although the Sheetz opinion is narrowly crafted, it provides new opportunities to challenge and to negotiate over impact fees and other legislatively adopted exactions.

Coblentz Patch Duffy & Bass LLP submitted an amicus brief on behalf of the Bay Area Council in support of the petitioner’s claims, explaining that the lack of a judicial check on impact fees has resulted in some excessively high fees and extreme variation in fees by jurisdiction, particularly in the Bay Area.

Case Background

The County of El Dorado’s Board of Supervisors enacted a traffic impact fee on new construction to finance new roads and the widening of existing roads. Under this program, the traffic impact fee was based on a rate schedule that took into account a project site’s location within the County and construction type. The fee was imposed regardless of a project’s actual impact on roads.

George Sheetz applied for a building permit from the County to construct a modest manufactured house on his property. The County issued a permit for the house on the condition that Mr. Sheetz pay the traffic impact fee in the amount of $23,420. Mr. Sheetz paid the fee under protest.

In 2017, Mr. Sheetz filed an action against the County, seeking a fee refund on the grounds that the traffic impact fee was an unconstitutional condition under the U.S. Supreme Court’s Nollan/Dolan precedent.

In rejecting Mr. Sheetz’s claims, the Court of Appeal held that, “[u]nder California law, only certain development fees are subject to the heightened scrutiny of the Nollan/Dolan test,” including “development fees imposed as a condition of permit approval where such fees are imposed . . . neither generally nor ministerially, but on an individual and discretionary basis.”[4] The Court reasoned that the requirements of Nollan/Dolan do not extend to development fees that broadly apply to property owners through legislative action, as opposed to fees imposed ad hoc on individual permit applications.

The California Supreme Court denied review, but the U.S. Supreme Court granted certiorari to answer the narrow question of whether legislatively adopted exactions are subject to the Nollan/Dolan test.

The Sheetz Decision and Key Takeaways

On the question presented, the unanimous Court was clear: the Takings Clause does not distinguish between legislative and administrative land use permit conditions, meaning that legislatively adopted exactions are subject to the Nollan/Dolan test. The Court stated that nothing in constitutional text, history, or precedent supports exempting legislatures from ordinary takings rules.

But the Court left open a number of issues and the three concurring opinions suggest that the Justices are not unanimous in their views of several ancillary, unanswered questions. For example, the Court explicitly did not address whether a permit condition imposed on a class of properties must be tailored with the same degree of specificity as a permit condition that targets a particular development. Justice Gorsuch’s concurring opinion took issue with the Court’s failure to reach this issue, stating that an “individualized determination” is required regardless of whether the fee impacts a class of properties or a particular development.[5] Justice Kavanaugh, joined by Justices Kagan and Jackson, disagreed in a concurring opinion emphasizing that the Court did not address the common government practice of imposing impact fees and other permit conditions through “reasonable formulas or schedules that assess the impact of classes of development rather than the impact of specific parcels or property.”[6] In a third concurring opinion, Justice Sotomayor, joined by Justice Jackson, stated that the trigger for Nolan/Dollan scrutiny is “whether the permit condition would be a compensable taking if imposed outside the permitting context.”[7] This may suggest that at least two Justices believe there might be an entirely different way to view impact fees, potentially outside of the takings jurisprudence.

Immediate and Long-Term Implications of Sheetz

Despite the open questions, Sheetz gives developers new options to challenge and negotiate over fees. Ever since the California Supreme Court in San Remo Hotel L.P. v. San Francisco[8] exempted legislatively adopted impact fees from the Nollan/Dolan test, local jurisdictions have had a powerful argument to rebuff fee challenges. With Sheetz, local jurisdictions have lost that tool. At the very least, we expect an uptick in impact fee litigation with greater success by developers. We also believe local jurisdictions will be more open to negotiation over impact fees as applied to individual projects.

California courts will now address some of the questions that the Justices left unanswered, and we expect this area will remain dynamic as new cases are decided. In fact, Sheetz itself lives on as the Court of Appeal is now considering how to apply the Supreme Court’s decision. We will be watching carefully as the courts confront the remaining open issues.

We do not expect that a large number of local jurisdictions will immediately revamp their existing fee programs. But as new fees are proposed or updated nexus studies are prepared, we anticipate that resulting fee programs will be tailored so that the fee imposed more closely matches the impact of the development. While Sheetz did not mark the end of impact fees (as some had predicted could happen with a more sweeping opinion), it likely will eventually result in fees that are more “proportional” to the impact.

For projects already struggling to pencil due to stubbornly high construction costs and interest rates, impact fees – sometimes reaching into six figures per unit – can pose additional barriers. As developers try to find ways to make projects viable, the Sheetz decision creates a stronger basis for revisiting impact fees that may be disproportionate to a project’s actual impacts.

 

[1] (2024) 601 U.S. 267.

[2] (1987) 483 U.S. 825.

[3] (1994) 512 U.S. 374.

[4] Sheetz v. County of El Dorado (2022) 84 Cal.App.5th 394, 406 (internal citations omitted), vacated and remanded by the U.S. Supreme Court.

[5] Sheetz v. County of El Dorado, supra, 601 U.S. at p. 283 (conc. opn. of Gorsuch, J.).

[6] Id. at p. 284 (conc. opn. of Kavanaugh, J.).

[7] Id. at p. 280–281 (conc. opn. of Sotomayor, J.).

[8] (2002) 27 Cal.4th 643.

 

The San Francisco Board of Supervisors recently amended the Planning Code’s controls to further regulate Fleet Charging and Parcel Delivery Service uses, primarily affecting Production, Distribution, and Repair (PDR) zoning districts. Below, we provide an overview of the legislative changes.

Fleet Charging Background

Fleet Charging[i] describes facilities that exclusively serve commercial or institutional vehicular fleets, including autonomous vehicles. These are distinguished from Electric Vehicle Charging Locations, which are open to the public. Starting in 2022, the Planning Code has generally required a Conditional Use Authorization (CUA) in the zoning districts where Fleet Charging uses are allowed, and has prohibited Fleet Charging as an accessory use to any other principal use. In most PDR districts (PDR-1-D, PDR-1-G, and PDR-2), however, an exception was available to convert existing private parking lots or vehicle storage lots to Fleet Charging uses by right, without a CUA.

Updated Fleet Charging Legislation

In 2023, Supervisor Peskin introduced amendments to the Fleet Charging legislation, which were unanimously approved by the Board on March 5, 2024 and signed by the Mayor on March 15, 2024. The amendments do not change the zoning districts where Fleet Charging uses may be allowed, but require a CUA in all PDR districts, regardless of the existing or former use of the site. This change removed the by-right exception available in three PDR districts to convert existing private parking lots or vehicle storage lots to Fleet Charging uses. Development applications submitted before January 11, 2024 are grandfathered into the prior regime.

Parcel Delivery Service Background

Demand for Parcel Delivery Service[ii]—a use category that includes traditional package shipping providers as well as services for delivery of e-commerce goods, food orders, cannabis, and more—has grown in recent years, largely in response to online shopping and fast delivery guarantees. In San Francisco, Parcel Delivery Service was historically permitted in districts that allow PDR uses, generally clustered in the southeast sector of the City.

In 2022, District 10 Supervisor Walton introduced and the Board approved interim Parcel Delivery Service controls, initially effective for 18 months between April 1, 2022, and September 30, 2023, and later amended and extended to March 30, 2024. Although sometimes described as a “moratorium,” the interim controls did not prohibit new Parcel Delivery Services, but newly required a CUA for those uses in all zoning districts. (The interim controls included a CUA exemption for temporary Parcel Delivery Services for up to 60 days within a 12-month period). Subsequent legislation prohibited Parcel Delivery Service activity, including unloading, sorting, and/or reloading merchandise, as part of a Fleet Charging use.

The Planning Department’s post-passage report from March 30, 2023 noted that several cannabis delivery businesses were impacted by the interim controls because they were classified under the Parcel Delivery Service definition.

Updated Parcel Delivery Service Legislation

As the extended Parcel Delivery Service interim controls were set to expire, the Board amended the Planning Code on March 5, 2024 (signed by the Mayor on March 15, 2024) to establish permanent regulations for these uses. In general, the changes are focused in the following areas:

• In zoning districts where Parcel Delivery Services were generally permitted prior to the interim controls (PDR, M Industrial, and C-3 districts), those uses now require a CUA. This includes Parcel Delivery Service uses of 5,000 SF or less, which did not trigger a CUA under the amended interim controls.
• Except for Parcel Delivery Service for cannabis and cannabis products, Parcel Delivery Service uses are not allowed to be accessory to any other use and must be an established principal use.
• CUAs for Parcel Delivery Services greater than 5,000 SF are subject to additional criteria, including analyses regarding 1) impacts to traffic patterns, queuing times, and total vehicle miles traveled, 2) greenhouse gas emissions resulting from operation of the site, and 3) a study evaluating the potential economic impact of the proposed project, including an employment analysis (projecting construction and permanent employment generated and discussing the employer’s wages and benefits provided) and a fiscal impact analysis (itemizing public revenue created and public services needed).
• All Parcel Delivery Service uses, regardless of size, are also subject to “at least the following conditions of project approval”: on-site electrification (including battery storage requirements) and vehicle idling prohibitions.

The Board is currently considering additional amendments, introduced by Supervisor Chan, that would add a new CUA criterion regarding impacts to educational institutions located near a proposed Parcel Delivery Service site and refine the existing employment analysis criterion to study AI utilization and use of autonomous vehicles. We’ll continue to track these and other important legislative updates affecting Fleet Charging and Parcel Delivery Service uses in the City’s PDR districts.

 

 

[i] Defined in the Planning Code as “Automotive Use, Non-Retail that provides electricity to electric motor vehicles through one or more Electric Vehicle Charging Stations that are dedicated or reserved for private parties pursuant to contract or other agreement and are not available to the general public. Fleet Charging is not allowed as an accessory use to any other principal use. Parcel Delivery Service activity, including unloading, sorting, and/or reloading merchandise for deliveries, is prohibited as part of a Fleet Charging use.”

[ii] Defined in the Planning Code as “[a] Non-Retail Automotive Use limited to facilities for the unloading, sorting, and reloading of local retail merchandise for deliveries, including but not limited to cannabis and cannabis products, where the operation is conducted entirely within a completely enclosed building, including garage facilities for local delivery trucks, but excluding repair shop facilities. Within PDR Districts, this use is not required to be operated within a completely enclosed building. Parcel Delivery Service for merchandise or products other than cannabis and cannabis products is not allowed as an accessory use to any other principal use.”

 

 

Voters in San Francisco and California will again confront a formidable ballot during the election on March 5, 2024, with an array of qualified City measures and one state proposition to consider. Key measures related to real estate and housing are as follows:

San Francisco Proposition A (Affordable Housing Bonds): Proposition A would allow the City to borrow up to $300 million by issuing general obligation bonds to construct, develop, acquire, and/or rehabilitate affordable housing. Of that $300 million:

• Up to $240 million of bond proceeds would be used for new rental housing, including senior and workforce housing, for extremely low-income, very low-income, and lower-income households.
• Up to $30 million would be used to preserve existing affordable housing that is affordable for lower-income and moderate-income households.
• Up to $30 million would be used to serve extremely low-income, very low-income, and/or lower-income households who need safe and stable housing and are experiencing street violence, domestic violence and abuse, sexual abuse and assault, human trafficking, or other trauma relating to homelessness.

The measure proposes to raise these funds through an estimated average tax of 57 cents per $100 of assessed property value. For rent controlled units, landlords can pass through to tenants 50 percent of this real property tax increase. The Citizens’ General Obligation Bond Oversight Committee would audit the expenditure of these bond proceeds.

One of the major drivers of the measure is the City’s need to meet its state-mandated Regional Housing Needs Allocation of over 46,000 affordable housing units by 2031, which we’ve written about here and here.

Support and Opposition: Proposition A was placed on the ballot by an 11-0 vote of the Board of Supervisors, the ordinance for which was signed by the Mayor. Proponents of Proposition A, including Board of Supervisors President Aaron Peskin, the SF Democratic County Central Committee (DCCC), SPUR[1], TogetherSF, SF YIMBY, the San Francisco Labor Council, the San Francisco Chronicle, the Council of Community Housing Organizations, the San Francisco Tenants Union, and the Mission Housing Development Corporation, argue that the measure provides essential affordable housing for working parents and families, teachers, firefighters, nurses, veterans, and seniors on fixed incomes. Opponents, including Larry Marso, argue that the City should push back against state-mandated housing levels, reign in borrowing, and protect against rising property taxes on existing home owners.

Proposition A requires a two-thirds vote to pass.

San Francisco Proposition C (Real Estate Transfer Tax Exemption and Office Space Allocation): For any property owner that receives permission to convert a property from commercial to residential use before January 1, 2030, Proposition C would exempt its initial post-conversion transfer from the transfer tax, up to a combined limit of 5 million square feet of space converted. The measure also allows the Board of Supervisors to amend the transfer tax without voter approval (but not to increase it), and permits office space that has been converted or demolished to be returned to the Proposition M allocation pool for allocation to new office developments of at least 50,000 square feet.

Support and Opposition: Proposition C was placed on the ballot by the Mayor, and is supported by certain members of the Board of Supervisors, the Housing Action Coalition, GrowSF, SF YIMBY, SPUR, TogetherSF, YIMBY Action, Senator Scott Wiener, the San Francisco Chronicle, and various small business and merchants associations, who assert that the City’s current transfer tax – which is up to 6 percent on transactions of $25 million or more – is a significant barrier to a more vibrant downtown and disincentivizes the conversion of underused office buildings to housing. Opponents of the proposition, including Supervisor Dean Preston, John Avalos, the SF DCCC, the Affordable Housing Alliance, the San Francisco Labor Council, the San Francisco Tenants Union, and the Harvey Milk LGBTQ Democratic Club, maintain that the measure would take power away from the voters, provide unnecessary tax breaks to the rich, and limit funding for vital City services. A recent report by the Office of the Controller concludes that although the goals of revitalizing San Francisco’s downtown and increasing housing opportunities are important, office to residential conversion may not be currently financially feasible, and the proposed incentive is likely too small to close the feasibility gap.

Proposition C requires a simple majority to pass.

San Francisco Proposition D (Changes to Local Ethics Laws): Proposition D would tighten City ethics laws, including by:

• Expanding the types and sources of gifts that City officers and employees are prohibited from accepting;
• Amending the definition of bribery to prohibit City officers and employees from soliciting or accepting anything of value for themselves or a third party with the goal of influencing any government action;
• Requiring City department heads to report additional information about gifts to their department and allowing discipline for failing to meet these requirements;
• Creating a uniform set of rules for all prohibited nonwork activities for City officers and employees;
• Allowing for monetary penalties when City officers and employees fail to make required disclosures about their personal, professional, or business relationships;
• Requiring all City employees with decision-making authority to complete an annual ethics training; and
• Requiring voter approval or supermajority votes by both the Board of Supervisors and the San Francisco Ethics Commission to amend most City ethics laws.

According to the Ethics Commission, these changes are also designed to standardize ethics rules and enforcement across City departments. If this measure passes, the provisions would become effective six months after the election.

Support and Opposition: Proposition D was placed on the ballot by a unanimous vote of the Ethics Commission in response to recent incidents involving corruption on the part of City officials and those doing business with the City. Proponents, including SPUR, the San Francisco Chronicle, the SF DCCC, the San Francisco Labor Council, and TogetherSF, argue that recent City government corruption lays out a case for much-needed internal reform. Opponents of the proposition, including Larry Marso and 11th Congressional District candidate Eve Del Castello, state that it is more efficient to have City departments set individual, tailored policies rather than creating a uniform set of rules and that the measure would continue to expand the headcount, and spending, within the Ethics Commission.

Proposition D requires a simple majority to pass.

California Proposition 1 (Behavioral Health Services Act and Behavioral Health Infrastructure Bond Act): Proposition 1 would authorize the state to sell a total of $6.4 billion in new bonds to build treatment facilities for those with mental health and substance use challenges (up to $4.4 billion) and to fund the state program that gives money to local governments to turn hotels, motels, and other buildings into housing and to construct new housing ($2 billion). Proposition 1 would amend the Mental Health Services Act (Proposition 63), which was passed by voters in 2004 and taxes individuals with incomes over $1 million per year, to allow funding to be used to treat substance use disorders (and not just mental health disorders), reallocate funding for full-service treatment programs, behavioral health services, and housing programs, and require annual audits of programs.

Support and Opposition: Proposition 1 was put on the ballot by the Legislature. Proponents, including Governor Gavin Newsom, California Professional Firefighters, the California Chamber of Commerce, the SF DCCC, the Veteran Mentor Project, the San Francisco Chronicle, SPUR, TogetherSF, and the National Alliance on Mental Illness–California, argue that the state’s mental health system is broken and that the proposition would move people permanently off the streets, out of tents, and into treatment. Opponents, including Senate Minority Leader Brian W. Jones, Assemblymember Diane B. Dixon, and Mental Health America of California, argue that Proposition 1 is a heavy burden on taxpayers and that a better tactic is to attack the problem of homelessness and mental health challenges through the regular budget process. They also assert that the proposition reduces local control, bringing a one-size-fits-all approach to a program that counties already offer.

Proposition 1 would modify Proposition 63 and requires a simple majority to pass.

 

 

[1] Links provided in this post to substantive voter guides, where available.

Throughout 2023, the State’s Department of Housing and Community Development (HCD) loomed large in San Francisco land use policy and politics. In January 2023, the City adopted and HCD certified a new Housing Element setting forth San Francisco’s plan for approving and building a State-mandated 82,000 new housing units over the next eight years (see earlier post). In October, HCD released its San Francisco Housing Policy and Practice Review, which concluded that San Francisco has the longest review and approval process for housing projects in the State. It deemed San Francisco an “outlier,” with “approval processes [that] are also notoriously complex and cumbersome, creating unpredictability and uncertainty.” At the end of the year, the Board of Supervisors passed the Constraints Reduction Ordinance contemplated in the Housing Element, after HCD advised in the fall that failure to do so could result in Housing Element de-certification.

The Constraints Reduction Ordinance makes numerous changes to the Planning Code to remove barriers to approving and building housing, particularly in well-resourced portions of the City that have traditionally seen less multifamily development. Among other changes, the Ordinance exempts certain housing projects from neighborhood noticing procedures; removes certain conditional use authorization requirements for some projects in lower height and density zoning districts; authorizes the Planning Commission to delegate to the Planning Director approval of many State Density Bonus Law projects without a conditional use or large project authorization; and relaxes rear yard, open space, and other development standards in specified zoning districts.

Looking ahead, no break in the action should be expected in 2024. In light of recent reporting that the City issued permits for only 581 new units in 2023—a 13-year low—we anticipate continued HCD oversight and involvement in the legislative process. In addition, SB 423, authored by Senator Scott Wiener (D – San Francisco) extended the SB 35 streamlined, ministerial approval program and added a San Francisco-specific annual HCD reporting and review requirement. If, as expected, HCD determines this year that San Francisco is not making adequate progress toward its market-rate housing production goals, a significantly larger number of predominantly market-rate housing projects may be eligible for streamlined, ministerial approvals.

As we discussed in prior posts from November 2022 and February 2023, San Francisco voters passed the Empty Homes Tax Ordinance, which is now codified in San Francisco Business Tax and Regulations Code Article 29A (the “Empty Homes Tax”), and becomes effective as of January 1, 2024.

San Francisco (the “City”) will impose the annual Empty Homes Tax on each person that owns a building with three or more “Residential Units” for keeping any of those units “Vacant” during the prior tax year. While the Empty Homes Tax will only apply to Vacant Residential Units, the filing requirement will apply to all non-exempt owners of Residential Units, even if no tax is due.

In the beginning of 2023, local landlords filed a lawsuit challenging the validity of the Empty Homes Tax. As discussed further at the end of this post, on December 20, 2023, the San Francisco Superior Court ruled that the case would be allowed to proceed, even though the Empty Homes Tax has yet to be assessed or collected—denying the City’s reliance on California’s longstanding “pay first, litigate later” rule.

Overview of the Empty Homes Tax

A “Residential Unit” for purposes of the Empty Homes Tax  means a “house, an apartment, a mobile home, a group of rooms, or a single room that is designed as separate living quarters, other than units occupied or intended for occupancy primarily by travelers, vacationers, or other transient occupants. Separate living quarters are those in which the occupants live and eat separately from any other persons in the building and which have a kitchen and direct access from the outside of the building or through a common hall.”

“Vacant” for purposes of the Empty Homes Tax means “unoccupied, uninhabited, or unused, for more than 182 days, whether consecutive or nonconsecutive, in a tax year.”

For purposes of the 182-day threshold, certain periods of vacancy are not counted. Periods of vacancy which are not counted toward the 182-day threshold include the following:

• Building Permit Application Periods – the period following the date that an application for a building permit for repair, rehabilitation, or construction with respect to a Residential Unit is filed with the City, through the date that the Department of Building Inspection grants or denies such application (not to exceed one year);
• Construction Periods – the one-year period following the date that the City issues a building permit for repair, rehabilitation, or construction with respect to a Residential Unit;[1]
• Disaster Periods – the two-year period following the date that a Residential Unit was severely damaged and made uninhabitable or unusable due to fire, natural disaster, or other catastrophic event;
• Homeowners’ Exemption Period – the period during which a Residential Unit is the principal place of residence of any owner of that Residential Unit and for which such owner validly has claimed either the homeowners’ property tax exemption under Section 218 of the California Revenue and Taxation Code or the disabled veterans’ exemption under Section 205.5 of that Code;
• Lease Periods – the period during which any owner of a Residential Unit or any person in the Owner’s Group (as defined in Article 29A) of that owner leases that Residential Unit to one or more tenants under a bona fide lease intended for occupancy, but not including any lease or rental of that Residential Unit to anyone in the Owner’s Group or to travelers, vacationers, or other transient occupants;
• New Construction Periods – the one-year period following the date that the City issues a certificate of final completion and occupancy with respect to a Residential Unit in a newly erected building or a newly added Residential Unit in an existing building;
• Owner Death Period – upon the death of an owner who was the sole occupant of a Residential Unit immediately prior to death, when such Residential Unit passes to a co-owner, or the deceased owner’s estate, heirs, or beneficiaries, the 182-day period does not include the period during which such Residential Unit is unoccupied, uninhabited, or unused due to the deceased owner’s death (limited to one year, unless such Residential Unit is subject to the authority of a probate court); and
• Owner in Care Periods – the period during which a Residential Unit is unoccupied, uninhabited, or unused because all occupants of the Residential Unit who used that Residential Unit as their principal residence are residing in a hospital, long term or supportive care facility, medical care or treatment facility, or other similar facility.

Exemptions & Exclusions

Excluded from the definition of “Residential Unit” are any units to which the Welfare Exemption from property tax applies, or any unit in an operational nursing home, residential care facility, or other similar facility. The Empty Homes Tax also provides a broader exemption for any organization with a valid exemption from income taxation under Section 501(c)(3) of the Internal Revenue Code.

Residential Units located in a building with two or fewer Residential Units are exempt from the Empty Homes Tax.

Filing Requirements and Applicable Rates

The Empty Homes Tax will apply beginning January 1, 2024, but will not be collected until 2025. The applicable rates for 2024 are as follows:

• $2,500 for each Residential Unit with square footage less than 1,000;
• $3,500 for each Residential Unit with square footage 1,000 to 2,000;
• $5,000 for each Residential Unit with square footage over 2,000.

Any person that owns a Residential Unit at any time during the tax year, unless exempt from the Empty Homes Tax pursuant to the exemptions described above or covered by the homeowners’ exemption period for the entire year, must file a return for that tax year with the Tax Collector. That is, all owners of Residential Units, unless exempt, must file a return—even if no Residential Units are vacant and even if no Empty Homes Tax is due for the year.  The Tax Collector has not yet released the form of the Empty Homes Tax return, but filing requirements and collection of the Empty Homes Tax will begin in 2025.

Update on Pending Litigation

In February of 2023, the San Francisco Apartment Association, the Small Property Owners of San Francisco Institute, the San Francisco Association of Realtors, and four individual landlords filed a lawsuit in San Francisco Superior Court challenging the constitutionality of the Empty Homes Tax. The lawsuit was brought under California Government Code Section 50077.5, which allows for challenges to test the validity of a voter-approved special tax.

The City’s primary defense in the lawsuit thus far has been that California law does not allow for a challenge to the Empty Homes Tax, and, if a challenge is available, it would only be available after the payment of the tax.

On December 20, 2023, the Superior Court overruled the City’s challenge, meaning that the lawsuit may proceed and the validity of the Empty Homes Tax may be challenged, even though the tax has not yet been assessed or collected. However, unless or until the resolution of the lawsuit results in changes to the Empty Homes Tax, the tax will take effect beginning in 2024.

We will continue to provide further updates on the Empty Homes Tax and the status of the lawsuit when they are available.

 

 

[1] However, if the City issues multiple building permits to or for the benefit of one or more persons in the Owner’s Group (as defined in SF Bus. Tax. & Reg. Code § 2952) for the same Residential Unit, the Construction Period shall mean only the one-year period following the issuance of the first building permit to or for the benefit of anyone in the Owner’s Group.

 

In 2018, San Francisco voters passed the Early Care and Education Commercial Rents Tax (“Commercial Rents Tax”), which became effective as of January 1, 2019. The Commercial Rents Tax generally imposes a 3.5% surtax on amounts that a business receives from the lease or sublease of commercial spaces in the City, and a 1% surtax on leases or subleases of certain warehouse space. There have been multiple challenges to the constitutionality of the Commercial Rents Tax, but it has been upheld.[1]

In April of 2023, a San Francisco taxpayer (“Taxpayer”) filed a complaint with the Superior Court of San Francisco, seeking a refund of approximately $1,861,000 for amounts overpaid for the Commercial Rents Tax, contending that a portion of its total gross receipts from leases used to calculate the Commercial Rents Tax did not constitute revenue from the lease of “commercial space,” as defined in the San Francisco Tax and Business Regulations Code.[2] “Commercial space” under the Commercial Rents Tax is generally defined as any building or structure, or portion of a building or structure, that is not “residential real estate,” subject to a number of exceptions based on the use of the building or structure.

Taxpayer operates a portion of its business in the City as a full service data center. A portion of the revenue under Taxpayer’s business model is allocable to its “colocation” data center, which Taxpayer asserted does not meet the definition of “commercial space” under the Commercial Rents Tax. “Colocation” services generally consist of renting space in data center facilities for the purpose of providing power, cooling, physical security for the server, storage, and networking equipment of customers. The agreement for colocation services is generally referred to as a “license” rather than a “lease.”

Taxpayer’s argument was that, under California law, “[a] license as to real estate is an authority to do a particular thing upon the land of another without possessing an estate therein. The test to determine whether an agreement for the use of real estate is a license or a lease is whether the contract gives exclusive possession as against all the world, including the owner, in which case it is a lease, or whether it merely confers a privilege to occupy under the owner, in which case it is a license.”[3] Generally, a licensee under a colocation agreement is limited in the manner of use of the  property, the location of where to place its equipment, the weight of the equipment, and alteration to the area around its equipment. A licensee cannot prevent the licensor from accessing the property. Thus, Taxpayer’s complaint asserted, colocation revenue should have been excluded from the calculation of the Commercial Rents Tax.

Taxpayer’s claim for refund also asserted that it overpaid Commercial Rents Tax by the improper inclusion of other amounts in the calculation of its total gross receipts, such as amounts derived from the need for specific machinery to be placed in its centers to support specialized computers for certain customers. Taxpayer argued that such revenue is not for commercial rental space and should not be considered in the calculation of the Commercial Rents Tax.

Although the case is still pending in Superior Court, an ordinance authorizing settlement of Taxpayer’s lawsuit against the City was introduced in June of 2023. The ordinance passed its first reading at a meeting of the Board of Supervisors on October 3, 2023, and passed its final reading before the Board of Supervisors on October 17, 2023. The ordinance was approved by the Mayor’s Office on October 20, 2023.

For space generating revenue that does not fit neatly within the definition of “commercial space” under the Commercial Rents Tax, and for revenue from commercial occupancy agreements that are more like a license than a lease, taxpayers may consider pursuing the exclusion of such amounts from the calculation of the tax. The success of a challenge to the application of the Commercial Rents Tax will depend, in large part, on the lease agreement and any other agreements with respect to the use of the space.

 

 

 

[1] See City and County of San Francisco v. All Persons Interested in the Matter of Proposition C on the November 6, 2018 San Francisco Ballot, No. CGC-19-573230 (Cal. Sup. Ct. S.F. County Jul. 5, 2019); see also Howard Jarvis Taxpayers Association, Building Owners and Managers of California, California Business Properties Association, and California Business Roundtable v. City and County of San Francisco and All Persons Interested in the Matter of Proposition C of the June 5, 2018 San Francisco Ballot, No. CGC-18-568657, (Cal. Sup. Ct. S.F. County Jul. 5, 2019).

[2] Verified Complaint for Refund of Business Taxes, Digital Realty Trust, Inc. v. City and County of San Francisco, No. CGC-23-605912 (Cal. Super. Ct. S.F.).

[3] Id. (citing Shaw v. Caldwell, 16 Cal. App. 1, 115 P. 941 (Cal. Ct. App. 1911)).