The uneven recovery of the Bay Area real estate market over the past year has created opportunities for real estate owners to challenge their property tax assessments. Areas that have experienced the strongest growth, as well as markets in which the recovery is lagging, may be ripe for challenges to property tax assessments.

Pregnant propositions

Under California’s Proposition 13, property taxes are based on the purchase price paid for a property or on the cost of constructing the property. Thereafter, Proposition 13 caps value increases (and property tax increases) at 2 percent annually.

When property values decline, Proposition 8, the bookend to Proposition 13, requires county assessors to reduce taxable property values below Proposition 13 value caps to reflect current market conditions. As real estate values recover following a downturn, assessors restore taxable values back to Proposition 13 levels.

Over the past year or so, core Bay Area markets (primarily San Francisco and the Silicon Valley) have experienced strong growth in market rents and declines in capitalization rates, particularly as compared to other Bay Area real estate markets. Because of the brisk recovery in core markets, county assessors have aggressively moved to restore 2012 values, determined as of Jan. 1, 2012, back to Proposition 13 levels. Such value restorations can bring major increases in assessments and taxes.

Assessors exercise value judgment

In order to restore property values to Proposition 13 levels, California requires county assessors to evaluate market sales and rental information. In so doing, assessors consider ranges of information on sales and rentals, and exercise their judgment as to whether values should fall in the top, middle or bottom of a range.

While assessors generally determine values for residential properties using computerized mass appraisal techniques, commercial properties tend to be more complex and require individual attention by assessor staff.

This year, the assessors in San Francisco and Santa Clara County have restored property values and assessments to levels at or near Proposition 13 amounts, which, in some cases, has dramatically increased tax bills as compared to 2011. In doing so, assessors may have justified assessments using more recent rental rates or cap rates, rather than using average rates during the 12 months prior to Jan. 1, which tends to accelerate value increases.

In 2012, most Bay Area counties announced increases in their property tax rolls.

The 2012 roll increases are due, at least in part, to increasing sales and leasing activity, which tend to be reflected in higher property tax values and assessments. However, these increases also reflect Proposition 13 value restorations described previously, and highlight those counties which merit increased consideration as far as whether to review and appeal property tax assessments.

Property tax appeal opportunities

The current situation presents several types of property tax appeal opportunities. First, for properties in San Francisco, San Mateo and Santa Clara counties, it is possible that assessors have been overly aggressive in restoring values to Proposition 13 levels. Taxpayers should request backup information supporting full or partial restoration of Proposition 13 levels and if the assumptions appear excessive, file an appeal.

This same advice goes for properties in secondary and tertiary markets, particularly where there have been Proposition 13 value restorations. Properties in these markets should also be reviewed, however, to determine whether they have participated in the economic recovery that San Francisco and the Silicon Valley have experienced. Economic recovery among Bay Area counties has been uneven, and hasn’t benefited every city within a county consistently.

In San Mateo County, for example, property values in Atherton have increased significantly, but values in East Palo Alto have continued to decline. Similarly, in Contra Costa County, values in five cities increased while in the county’s remaining 14 cities values generally declined.

Finally, property owners should not assume that a “no change” assessment or that a lower assessment by the local assessor is correct. Values in some areas declined during 2011, which means that market values as of Jan. 1, 2012 may be lower than 2011 values, and should not reflect value increases that have occurred during the first nine months of 2012.

Cris K. O’Neall specializes in property and local tax matters as a partner in the law firm of Cahill, Davis & O’Neall LLP, the California member of American Property Tax Counsel, the national affiliation of property tax attorneys.