COUNTY OF RIVERSIDE v. PALM RAMON DEVELOPMENT CO (1965)

These nine appeals from judgments of the superior court, after prior contemporaneous hearings before the Riverside County Supervisors sitting as a board of equalization, were consolidated on the appeal. They all involve the same basic question, namely, whether the County Assessor of Riverside County acted correctly in assessing the possessory interests of the defendants in land located in the Palm Springs area.

In form, these were actions brought by the county to collect the taxes for the tax year 1961–62 as determined by the assessor and approved by the county board of equalization. In their answers the appellants contended that the method of assessment was illegal; they argue that it violated the controlling judicial decisions of the California Supreme Court.

This appeal necessarily reviews the proceedings not only in the superior court but before the board of equalization, as no new or different evidence was introduced at the trial which affected the merits of the litigation. Upon analysis, the principal, if not the sole, questions in the case are whether or not the method prescribed by the Supreme Court as recently as 1955 after a complete survey of the law applicable to the assessment of possessory interests in land owned by the federal government should control and, if so, whether the rules laid down in those cases have been followed. These questioned opinions written by the present Chief Justice of the Supreme Court are: DeLuz Homes, Inc. v. County of San Diego, 45 Cal.2d 546, 290 P.2d 544; Fairfield Gardens, Inc. v. County of Solano, 45 Cal.2d 575, 290 P.2d 562; Victor Valley Housing Corp. v. County of San Bernardino, 45 Cal.2d 580, 290 P.2d 565; and El Toro Dev. Co. v. County of Orange, 45 Cal.2d 586, 290 P.2d 569. If the rules enunciated in those cases are in point here, it would seem apparent that the assessor has not followed them and that the judgments in the instant cases should be reversed in order that a fresh hearing to determine the factors necessarily involved can be carried on by the Riverside County Board of Equalization.

The fee title to all of the land involved in this litigation is held in trust by the United States of America for the benefit of members of the Indian tribe living in the vicinity of Palm Springs. The fee title is, therefore, exempt from taxation by virtue of the federal and state Constitutions and laws.

During the years 1959 and 1960, the Bureau of Indian Affairs and the Indian allottees executed leases in favor of the appellants. The terms of the leases, in most cases, were fixed at 25 years, with an option to the lessees to extend them for an additional 25 years. The leases provided that all existing improvements and those subsequently constructed on the land by the lessees would become the property of the Indian owners of the underlying fee; a minimum annual rental, substantial in amount, was required and there was usually a provision for additional rental consisting of a percentage of the gross income derived from the property, ranging, it is said, from 20 to 30 per cent; the lessees were further obliged to pay the expenses of operation and maintenance, and the insurance and taxes; the use of the property and the nature of the construction of buildings on it were made subject ot prior approval by the Indian owner. These leases were of commercial property intended to be developed, subleased, and rented to actual tenants for commercial or professional usage, and it follows naturally that it was expected at the time of the execution of the leases and is presently contemplated, that all of the property will actually produce income during the terms of the leases.

The procedure of the assessor was frankly and specifically stated by him and his deputies. The possessory interests of the lessees were considered in two parts: first, an estimate of the possessory value of the land and, secondly, an estimate of the possessory value of any buildings on the land; these two elements combined gave the assessed value of the lessees' interest in both land and improvements. In reaching his estimate of the value of the possessory interest in the land, the assessor first made a finding as to the fee value of the land itself; next, he determined the present value of the monetary right of the exempt owner of the fee to recover possession after 50 years; subtracted the latter figure from the former; made a conjectural deduction of 10 per cent to compensate for the risk and restrictions on use contained in the lease; then, applied his prevailing assessment ratio of 25 per cent to get the assessed value of the land which was subject to the application of the tax rate. With respect to the improvements, the assessor valued them as if owned in fee, in general accordance with his methods as used throughout the county, to assess the fee value of buildings and placed such amount on the tax roll as the value of the possessory interest in improvements.

Thus, it will be seen that the assessor did not apply the capitalization of income method to the tax year 1961–1962, saying that, in his opinion, there was a lack of sufficient experience as to actual income and expenses, and that any appraisal based on capitalization of income would not be reliable. The trial court approved the assessor's method, stating in its minute order for judgment in each case:

‘* * * it is the belief of this Court that the commercial approach is not the present method of evaluation for tax purposes approved by our Supreme Court.’

Findings and judgments and these appeals followed.

Article XIII, section 1, of the California Constitution requires:

‘All property in the State except as otherwise in this Constitution provided, not exempt under the laws of the United States, shall be taxed in proportion to its value, to be ascertained as provided by law, or as hereinafter provided.’

‘Since nonexempt possessory interests in land and improvements, such as the leasehold estates involved in the present actions, are taxable property [citing authorities], they too must be assessed at ‘full cash value.” (DeLuz Homes, Inc. v. County of San Diego, supra, 45 Cal.2d 546, 562–563, 290 P.2d 544, 554–555.)

What must be assessed here is not mere possession of the real property for a limited time, but the usufruct of the property during the term of the lease, that is to say, ‘the right of using and enjoying the profits of a thing belonging to another, without impairing the substance.’ (Douglas Aircraft Co. v. Byram, 57 Cal.App.2d 311, 316–317, 134 P.2d 15, 18; Heintzen v. Binninger, 79 Cal. 5, 6, 21 P. 377.) Even though for taxation purposes a possessory interest in land is classifiable in California as real property (Forster Shipbldg. Co. v. County of L. A., 54 Cal.2d 450, 455–456, 6 Cal.Rptr. 24, 353 P.2d 736), a lease for years is not technically an estate in the real property, but is actually a chattel real. (First Nat. Bank of Oakdale v. Brashear, 200 Cal. 389, 253 P. 143; Potts Drug Co. v. Benedict, 156 Cal. 322, 104 P. 432.) The possessory interest in the land and any buildings on it is measured by the properly ascertained value of that interest (Kaiser Co. v. Reid, 30 Cal.2d 610, 184 P.2d 879).

It is true that the leases here are much restricted in that (1) no sublease may be made without the approval of both the Indian owner and the Bureau of Indian Affairs; and (2) no substantial alteration, addition, or modification of the premises may be made without first securing the express approval of the Indian owner as to the design of the proposed buildings, the type of construction, the cost, the method of financing, and the ultimate use thereof. These restrictions necessarily constitute a serious interference with a possible sale of the leases and the record does not show that any of them involved here has been sold; however, notwithstanding the extreme paucity of a prospective market, it seems to be agreed by the parties as a reasonable deduction from the cases above cited that the assessor is bound to ascertain their actual or theoretical market value. (DeLuz Homes, Inc. v. County of San Diego, supra, 45 Cal.2d 546, 561, 290 P.2d 544.) But there is a sharp difference of opinion between counsel as to the proper method by which to achieve such an object.

It is, of course, no legitimate objection to the application of the method of assessment prescribed in the basic cases above cited that the work involved is difficult. As is said in Rittersbacher v. Board of Supervisors, 220 Cal. 535, 543, 32 P.2d 135, 139:

‘Obviously the enormous extent of the task can afford no justification for an illegal tax.’

It is our considered opinion that the method employed by the assessor was erroneous and that the rules announced in the DeLuz case, supra, must be applied. In this connection, we call attention to some of the fallacies in the method used by the assessor in the present cases:

(1) The assessor did not purport to value the leaseholds ‘* * * by the capitalization of income method, a generally accepted method of valuing property from which income may be or is derived. [Citing authorities.] According to this method, the value of property is the sum of anticipated future installments of net income from the property, less an allowance for interest and the risk of partial or no receipt. [Citing textbooks.] ‘[I]t involves a capitalization or discounted valuation of the realized or prospective net monetary income derivable by continuous exploitation rather than by resale.’' (DeLuz Homes, Inc. v. County of San Diego, supra, 45 Cal.2d 546, 564, 290 P.2d 544, 555.)

Instead of doing so, the assessor began his calculations by assuming that the fee title of the real property had a certain market value, and deriving his calculations as to the value of the possessory interests therefrom. It is by no means certain that such a basic datum was accurate in view of the ownership of the underlying fee title, or that any such assumed market value of the fee will continue unaffected for any specified time.

(2) The assessor calculated separately the value of the possessory interest in the real property and the value of the possessory interest in the improvements. The briefs of the parties confirm that, in appraising the improvements, the assessor used the ‘reproduction cost less depreciation’ method where the life of the lease was equal to or in excess of the anticipated useful life of the improvement. This method was expressly disapproved in Victor Valley Housing Corp. v. County of San Bernardino, supra, 45 Cal.2d 580, 582–583, 290 P.2d 565, 567, where the assessor valued the improvements at the ‘replacement cost of improvements, less deductions for depreciation and restrictions created by the lease,’ and in the companion case, El Toro Dev. Co. v. County of Orange, supra, 45 Cal.2d 586, 588, 290 P.2d 569, the court commented adversely on the assessor's similar method of valuing improvements.

Obviously, the leases and subleases in question included not only the several parcels of land but also the buildings on them, and it is improper separately to assess the possessory rights in the land and the possessory rights in the buildings.

(3) The assessor paid no attention to probable expenditures of the lessee during the unexpired term of the lease. The court said in Victor Valley Housing Corp. v. County of San Bernardino, supra, 45 Cal.2d 580, 584, 290 P.2d 565:

‘* * * the value of plaintiffs' possessory interests can best be estimated in terms of actual income rather than imputed income, and * * * in any event, an analysis of imputed income must make an adequate distinction between imputed gross income and imputed net income.’

Again, in the El Toro Development Co. case, supra, 45 Cal.2d 586, 588, 290 P.2d 569, 571, the assessor's method was repudiated, because he did not make such distinction. The court saying:

‘Since the assessor's imputed income anslysis made no distinction between imputed gross income and imputed net income, and since valuation of the leasehold may be more adequately made by capitalizing anticipated earnings, DeLuz Homes, Inc. v. County of San Diego, [45 Cal.2d p. 546], 290 P.2d 544, his valuation of the possessory interests in land and improvements cannot be sustained.’

Here, the necessity of calculating taxable value must take into consideration the monies that would have to be spent during the term of the lease by the lessee, so that net income, rather than gross income, must be the basis for the assessor's calculation of value.

(4) The assessor assumed that in each instance the lessee would necessarily extend his lease for the additional time provided in the option for extension. The period of the lease in most cases was 25 years with an option to extend the term for an additional period of 25 years. It would not necessarily follow that a lessee would exercise his option; as the term of the lease was not presently assured for the additional 25 years it was erroneous to include that item in addition to the existing term.

(5) The reduction of the basic value of the real property by 10 per cent to allow for restrictions and other adverse terms was a figure plucked out of the air without any evidence to support it.

(6) There is nothing to show the correct rate of capitalization; whether six per cent, eight per cent, or some other figure is correct must depend upon the facts as established in these cases before the board of equalization.

We conclude from a close analysis of the record and the briefs and oral arguments of the parties that the respondent has, without just cause, departed from the rules enunciated by the Supreme Court and which, of course, are binding upon every one, including county officials and taxpayers. After what obviously constituted an intensive study of this complicated problem, the Supreme Court set up an exhaustive method of ascertaining legitimate taxation of possessory rights when the fee title is exempt under the federal and state Constitutions. Not only did the court establish requisite methods, but it gave detailed reasons for the steps prescribed. While some benevolent fictions are inevitably included in order to constrain future uncertainties to the mathematical exactitude of the assessor's roll, these rules conform, by and large, with methods of appraisement approved in current textbooks on the subject, and they should be applied by the assessors of this state without quibble.

The respondent alleges that at the sessions of the county board of equalization the appellants did not make clear in what specific respects the assessor departed from the prescribed rules or what detailed results would have followed an application of the correct method of assessment. We are forced to admit that the record of the hearings before the board of equalization constituted ‘confusion worse confounded,’ but we bear in mind that the DeLuz case, supra, was cited frequently at the hearings and that the application of the rules promulgated in that case, and its companion cases, was the essential subject of the enquiry. Furthermore, as made clear in this court during the oral argument, the controversy still rages with respect to assessments for years subsequent to 1961–62 and there are cases, actual or potential, embodying the same basic question which is present here, with respect to taxes for those later years. Efficient administration requires a timely solution based on principle.

Once again, we adopt for all of the nine consolidated cases the same directions, with a few indicated changes, that were made by the Supreme Court in the DeLuz case, supra, 45 Cal.2d at page 574, 290 P.2d at page 562:

‘The proceedings must be remanded to the county board of equalization for determination of the value of the possessory interests and the texes thereon. Universal Consol. Oil Co. v. Byram, 25 Cal.2d 353, 362–363, 153 P.2d 746. The board shall take evidence on annual anticipated gross income, operating and maintenance expenses, * * * and the percentage that will adequately allow for taxes. Moreover, since the rate of capitalization is predicated on the risk, interest, and provisions for replacement of capital relative to the investment to which it is applied (see, 1 Bonbright, op. cit. supra, pp. 259–262), the board shall take evidence on these matters and ascertain therefrom the proper rate of capitalization. It shall deduct annual operating and maintenance expense and * * * shall capitalize the difference at the rate that it determines will allow for risk, interest, and taxes.’

The period of capitalization shall be the remaining years of each of the leases without taking into consideration any unexercised option to extend the term of the lease. The detailed methods set forth in DeLuz Homes, Inc. v. County of San Diego, supra, 45 Cal.2d 546, 290 P.2d 544, shall be utilized in determining the assessments.

The judgments are reversed with directions to the trial court to remand the proceedings in all of the consolidated cases to the county board of equalization for action in accordance with this opinion.

CONLEY, Presiding Justice.

R. M. BROWN and STONE, JJ., concur.