Filed 1/30/15 Two v. County of Orange CA4/3




                      NOT TO BE PUBLISHED IN OFFICIAL REPORTS
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               IN THE COURT OF APPEAL OF THE STATE OF CALIFORNIA

                                     FOURTH APPELLATE DISTRICT

                                                DIVISION THREE


DYANLYN TWO et al.,

     Plaintiffs and Appellants,                                        G049269

         v.                                                            (Super. Ct. No. 30-2012-00618968)

COUNTY OF ORANGE,                                                      OPINION

     Defendant and Respondent.



                   Appeal from a judgment of the Superior Court of Orange County, Linda S.
Marks, Judge. Reversed and remanded with directions.
                   Law Offices of Wade E. Norwood and Wade E. Norwood for Plaintiffs and
Appellants.
                   Nicholas S. Chrisos, County Counsel, and Laurie A. Shade, Senior Deputy
County Counsel, for Defendant and Respondent.
              This case concerns the County of Orange’s property tax reassessment of a
retail shopping center located in the City of Westminster. The Assessment Appeals
Board and the trial court both concluded reassessment was proper because there was a
change of ownership of the subject property when it was purchased by the long-term
lessee and a third party investor. We conclude there was no change of ownership for
property tax purposes and reverse the trial court’s judgment.
                                              I
              The parties do not dispute the facts of the various transactions in this case,
only the legal conclusions to be drawn from them. The appeal concerns “the Golden
Westminster Specialty Center” located at 15212 and 15300 Goldenwest Street (the
property). It consists of two adjoining parcels of improved real property identified as
Assessor’s Parcel Numbers 142-383-13 and 142-401-62.
              In 1977, the owners of the subject property1 entered into a 60-year ground
lease with Golden Westminster Specialty Center (Golden Westminster). The term was
from June 15, 1977, to June 14, 2037. The lease contained a purchase option permitting
Golden Westminster to purchase the subject property during either the 25th year of the
ground lease (2002), or the 30th year of the ground lease (2007). Golden Westminster
was required to give 60 days’ written notice if they intended to purchase the property.
              At the time, Golden Westminster was a general partnership comprised of
John P. Sullivan, individually, and Dyanlyn Development Company, a general
partnership. Dyanlyn Development Company was comprised of general partners Diane
Kolodziejski and L. Herbert Lundin. Sullivan, Kolodziejski, and Lundin executed the
60-year lease on behalf of Golden Westminster.


1              The original landlord was Crocker National Bank (Crocker) as corporate
co-trustee for Carpenters Pension Trust for Southern California. After several years the
trustee changed from Crocker to Union Bank and then to CPT/SC Title Holding
Corporation.

                                              2
              Golden Westminster constructed a shopping center on the land and
operated it for 30 years. In early December 2006, the landlord and Golden Westminster
amended the lease, extending its term by an additional 15 years to June 30, 2052.
              On December 28, 2006, the landlord sold the property to the following
parties: (1) 25 percent to the Gail & John Sullivan Revocable Trust; (2) 25 percent to
Sechelt Associates, LP; and (3) 50 percent to Dyanlyn Two (collectively referred to
Dyanlyn unless the context requires otherwise). These entities purchased the property as
tenants-in-common.
              The following day, December 29, 2006, the parties recorded the following
documents regarding the sale: (1) a grant deed transferring title from the landlord to
Dyanlyn; (2) an assignment of lessor’s interest in the lease (executed December 22,
2006); (3) an assignment and assumption of lessor’s interest in the ground lease
(executed December 16, 17 & 20, 2006); (4) a deed of trust and assignment of rents from
Golden Westminster to Chicago Title Company and West Coast Life Insurance Company
(executed December 1, 2006); and (5) an assignment of rents and leases and joinder
(executed December 1, 2006).
              The County of Orange (hereafter the Assessor) reassessed the property after
it discovered the sale and change of ownership to Dyanlyn. For one parcel, the Assessor
enrolled a value of $8,624,916, with $7,129,588 allocated to the land and $1,495,328
allocated to the improvements. For the second parcel, the Assessor enrolled a value of
$6,625,267, with $4,460,457 allocated to the land and $2,164,810 allocated to the
improvements.
              Dyanlyn filed applications for changed assessments with the Assessment
Appeals Board (the AAB). It disputed whether a reassessable change of ownership
occurred when it purchased the property. Dyanlyn also disputed the enrolled values,
arguing the first parcel should be valued at $6,399,000, and the second at $4,900,000.



                                             3
              During a two-day hearing, the AAB considered written briefs, documentary
evidence, and testimony. The AAB took the matter under submission and issued a ruling
on June 28, 2012. The AAB concluded, “[T]he December 2006 sale of the subject
property, although subject to the long term lease of greater than 35 years, was a change of
ownership. The AAB reject[ed the] Assessor’s argument that the amendment [of the
lease] was not in place before the sale and [found] credible the evidence on this point,
including the statements within the [d]eclaration of . . . Lundin . . . .”
              Lundin’s declaration stated Golden Westminster constructed improvements
and a shopping center on the subject property, but the rents were relatively low because
of the shopping center’s location. Golden Westminster was only making a very small
profit. Under the terms of the purchase option formula, Golden Westminster could
acquire the property for the fair market value of the land not subject to the lease or
subleases, or the fair market value subject to the leases. The property owners determined
the land was worth $7.1 million when not subject to the leases, which was “significantly
more than the actual value of the land, encumbered as it was with the [g]round [l]ease
and subleases to the tenants[.]”
              Lundin explained in his declaration that Golden Westminster could not
afford to exercise the option at $7.1 million, but he was “reluctant to let [the owner] take
[Golden Westminster’s i]mprovements plus all its right, title and interest at the end of the
ground lease term” in 2037. Lundin stated the only way he could finance the acquisition
“at the inflated price” was to create “an entity” that he structured by “borrowing against
other properties owned by [him]self, [his] partners in [Golden] Westminster, and a new
co-venturer.” He declared, “However, in order to justify the investment of $7.1 million,
it was necessary to extend the term of the [g]round [l]ease . . . from 2037 to 2052—an
additional [15] years—we increased the period over which the entity could amortize the
purchase price, thereby doubling the yield on its investment (from 1 [percent] to



                                               4
2 [percent].)” Lundin added, “Although [the owners] understood that extending the
[g]round [l]ease could facilitate the exercise of the buyout option under the [g]round
[l]ease, it was not clear at the time the [lease] was extended that [Golden] Westminster
would be able to put together a consortium to acquire the [p]roperty. [The owner] and
[Golden] Westminster independently agreed to extend the [lease], which extension would
be binding regardless of whether the [subject property] was purchased through the
[g]round [l]ease option.”
               The AAB agreed with the parties that the lease extension amendment and
the later sale “would each be exempt from property tax reassessment” pursuant to
Revenue and Taxation Code section 62, subdivision (g), (hereafter referred to as the
62(g) exception).2 It noted the parties conceded there was no legal authority addressing
the type of transaction involved in their case. The AAB determined two tests set forth in
the Shuwa Investments Corp. v. County of Los Angeles (1991) 1 Cal.App.4th 1635, 1648
(Shuwa) case were applicable. Applying these tests, the AAB explained, “It becomes
clear that there was a reassessable change in ownership when the fee owner of the subject
property . . . deeded the subject property to [Dyanlyn.]” And finally, the AAB agreed
with Dyanlyn that the Assessor overvalued the property. It determined one property was
worth $7,752,000, and the second was worth $5,848,000, for a total value of
$13,600,000.
               Dyanlyn decided to challenge the AAB’s decision in superior court and
filed a complaint seeking a refund of property taxes. It challenged the AAB’s conclusion
there was a reassessable change in ownership but did not seek review of the AAB’s
downward modification of value.
               The trial court held a hearing on August 15, 2013, and took the matter
under submission. On September 9, 2013, it issued a minute order in favor of the

2            All further statutory references are to the Revenue and Taxation Code,
unless otherwise indicated.

                                             5
Assessor. The court made the following findings: (1) Golden Westminster could not
afford to exercise the option to purchase the subject property; (2) in early December
2006, Golden Westminster and the property owner extended the lease for an additional
15 years making the lease run for 45.5 years; and (3) within a few weeks after the
extension, the lessee and a new investor purchased the subject property.
              The trial court recognized the buyers were claiming the sale was not a
change of ownership because the property was encumbered by a lease longer than
35 years (triggering 62(g) exception). The court determined the exception should not
apply, stating “Golden Westminster seeks to gain in the transaction as both a purchaser
and lessee of the property at issue.” The court explained the legislative purpose would
not be served and reasoned the exception should apply when the sale involves a third
party transfer over which the lessee had no control. It noted that in this case Golden
Westminster “had a direct interest in having the property sold to investors in order to
preserve its right to exercise an option to purchase the property prior to the lease term
ending.” The court determined, “It appears that Golden Westminster orchestrated the
series of transactions in order to avoid losing the property.” The trial court ruled the
Assessor properly reassessed the property as a result of the sale and correctly applied the
“end result” test, treating the lease extension (step 1) and sale (step 2) as one transaction
taken to evade reassessment. Dyanlyn appealed.
                                              II
A. Standard of Review
              “‘It is well settled that the interpretation and application of a statutory
scheme to an undisputed set of facts is a question of law [citation] which is subject to
de novo review on appeal. [Citation.] Accordingly, we are not bound by the trial court’s
interpretation. [Citation.]’ [Citation.] An appellate court is free to draw its own
conclusions of law from the undisputed facts presented on appeal. [Citation.]”



                                              6
(McMillin-BCED/Miramar Ranch North v. County of San Diego (1995) 31 Cal.App.4th
545, 553 (McMillin).)
              “In Shuwa, supra, 1 Cal.App.4th at [page] 1644, the court stated the
standard of review simply: ‘What constitutes a “change in ownership” is a question of
law subject to this court’s independent de novo judicial review. [Citation.]’ It occurs to
us, however, that the application of the step transaction doctrine requires an analysis of
the parties’ purposes and intents in carrying out the various steps in the transaction.
[Citation.] Such issues as intent and purpose are customarily viewed as factual issues.
Even though there was essentially no factual dispute in this case, we find the Supreme
Court’s analysis of mixed questions of law and fact to be of assistance here: ‘Questions
of fact concern the establishment of historical or physical facts; their resolution is
reviewed under the substantial[]evidence test. Questions of law relate to the selection of
a rule; their resolution is reviewed independently. Mixed questions of law and fact
concern the application of the rule to the facts and the consequent determination whether
the rule is satisfied. If the pertinent inquiry requires application of experience with
human affairs, the question is predominantly factual and its determination is reviewed
under the substantial[]evidence test. If, by contrast, the inquiry requires a critical
consideration, in a factual context, of legal principles and their underlying values, the
question is predominantly legal and its determination is reviewed independently.
[Citation.]’ [Citation.] [¶] Here, . . . the decision of the superior court amounts to the
resolution of a number of questions of law and mixed questions of law and fact that were
predominantly legal in nature, rather than factual. Any factual issues raised by the
declarations presented below are subordinate to the overall legal questions presented by
the statutory interpretation question. We emphasize this point at some length due to our
concern that there is an anomaly in the use of a pure de novo standard in this particular
area of tax law. However, this de novo standard of review is well enough established for
us to proceed to determine the issue anew.” (McMillin, supra, 31 Cal.App.4th at p. 554.)

                                              7
B. Applicable Law—Proposition 13
              “Proposition 13, adopted in 1978, limits the amount that the assessed value
of real property may be increased to reflect increases in the property’s actual market
value. When ownership of the property changes, however, the property may be
reassessed at its current market value. [Citation.] Changing the assessed value of real
property to its current market value can result in a substantial increase in the tax on that
property. Thus, determining whether and when a change of ownership has occurred can
have significant tax consequences.” (Auerbach v. Assessment Appeals Bd. No. 1 (2006)
39 Cal.4th 153, 157.)
              “Because Proposition 13 did not explicate the meaning of ‘change in
ownership’ [citations], it fell to the Legislature to define the phrase, a task it has striven to
perform during the [many] years since Proposition 13 was adopted by the electorate. The
main effort to create consistent and uniform guidelines to implement Proposition 13’s
undefined ‘change in ownership’ provision was undertaken by a 35-member panel that
included legislative and board staff, county assessors[,] . . . trade associations, and
lawyers in the public and private sectors. The panel’s work culminated in the Report of
the Task Force on Property Tax Administration (hereafter task force report), which was
submitted to the Assembly Committee on Revenue and Taxation on January 22, 1979.
[¶] . . . [¶] [T]he task force recommendations resulted in the enactment of the Revenue
and Taxation Code provisions now before us. The Legislature adopted some of the
recommendations verbatim or with nonsubstantive technical revisions, and others with
rather minor changes. The report’s key change-in-ownership test was adopted verbatim
and is now codified as section 60, quoted hereafter. [¶] The task force report drafters
stressed the need for uniformity and consistency in the application of section 60’s general



                                               8
rule.” (Pacific Southwest Realty Co. v. County of Los Angeles (1991) 1 Cal.4th 155,
160-161 (Pacific).)3
              Section 60 defines “‘Change in ownership’” as “[A] transfer of a present
interest in real property, including the beneficial use thereof, the value of which is
substantially equal to the value of the fee interest.” Our analysis of the transactions in
this case starts with understanding the elements of this test.
C. Understanding Section 60’s Three-Part Test
              “Section 60’s governing test contains three parts . . . [and t]o determine
whether the transaction in the case at bar worked a change in ownership under
Proposition 13, we begin with that test.” (Pacific, supra, 1 Cal.4th at p. 162.) A change
of ownership means a transfer of (1) “a present interest in real property,” (2) “including
the beneficial use thereof,” and (3) “the value of which is substantially equal to the value
of the fee interest.” (§ 60.) These three elements are commonly referred to as
“present interest,” “beneficial ownership,” and “value equivalence.”
              In interpreting section 60, courts (and the Assessor) rely on the
explanations set forth in the task force report. (Pacific, supra, 1 Cal.4th at p. 161 [citing
task force report].) The report explains a “present interest” in the property is “necessary
to protect a variety of contingent or inchoate transfers from unintended change of
ownership treatment, including future interests, revocable transfers and transfers with
retained life estates.” (Task force rep., supra, at p. 39.) The task force determined the
beneficial ownership component is “necessary to protect custodianships, guardianships,
trusteeships, security interests, and other fiduciary relationships from unintended change


3            On our own motion, we take judicial notice of the Report of the Task Force
on Property Tax Administration submitted to the Assembly Committee on Revenue and
Taxation on January 22, 1979 (hereafter task force report).

                                              9
in ownership treatment.” (Ibid.) And finally, the task force included the “value
equivalence” element as part of the test, finding it “necessary to determine who is the
primary owner of the property at any given time.” (Ibid.)
              The task force explained, “Often two or more people have interests in a
single parcel of real property. Leases are a good example. The landlord owns the
reversion; the tenant, the leasehold interest. Suppose the landlord sells the property
subject to the lease and the lessee assigns the lease. Which sale or transfer is the change
of ownership? [¶] The example illustrates that in determining whether a change in
ownership has occurred it is necessary to identify but one primary owner. Otherwise
assessors would be forced to value, and account for separate base year values for
landlords and tenants on all leases, and for other forms of split ownership. This would
enormously complicate the assessor’s job. [¶] A major purpose of this third element,
therefore, is to avoid such unwarranted complexity by identifying the primary owner, so
that only a transfer by him will be a change in ownership and when it occurs the whole
property will be reappraised.” (Task force rep., supra, at pp. 39-40.)
              The task force added, “If the hypothetical lease previously mentioned was a
short term lease (and the landlord owned the main economic value), the landlord’s sale,
subject to the lease would count. If, on the other hand, the lease was a long term lease
(the lessee’s interest was the main economic package), the lease assignment would count.
In either case the entire fee value of the leased premises would be reappraised.” (Task
force rep., supra, at p. 40.) The Supreme Court, adopting this language, held a change of
ownership occurs only “when the primary economic value of the land is transferred from
one person to another.” (Pacific, supra, 1 Cal.4th at p. 167.) Thus, when multiple parties
have an interest in property the court must identify who is the primary owner.
              The task force recommended specific examples (relating to common
transactions) be included in the statutory scheme for assessors and taxpayers to rely on.
The task force stated, “Leases are a good illustration of the necessity of concrete statutory

                                             10
examples. Both taxpayers and assessors need a specific test—rather than the broad
‘value equivalence’ test—to determine the tax treatment of leases. The specific test,
however, must be consistent with the ‘value equivalence’ rule and have a rational basis.”
(Task force rep., supra, at p. 41.)
              The task force concluded the lessee of a lease lasting longer than 35 years
should be deemed the primary owner of the property for property tax purposes. The task
force explained, “Lenders will lend on the security of a lease for 35 years or longer.
Thus, 35 years was adopted as the concrete dividing line. If the term of a lease, including
options to renew, is 35 years or more, the creation of the lease is a change in ownership
and so is its expiration. If a lessee under such a lease assigns or sublets for a term of 35
years or more, that is another change in ownership. However, if the lease, including
options, is for less than 35 years the lessor remains the owner and only the transfer of his
interest is a change. In all cases, the entire premises subject to the lease in question are
reappraised.” (Task force rep., supra, at p. 41.)
              Based on the task force’s recommendation, the Legislature enacted sections
61 and 62 to codify the concept that the “value equivalence” element must be determined
by reference to the lease duration. Before discussing these code provisions, we note the
Board of Equalization (the Board) has sought to interpret these statutes and enacted
several related property tax rules, contained in title 18 of the California Administrative
Code (hereafter referred to as the Rules). Thus, our discussion of the issue will include
analysis of these rules. In addition, we have reviewed and refer in this opinion to
“annotations” and advisory opinions published by the Board. “‘Annotations’ are
published in either the Business Taxes Law Guide or the Property Taxes Law Guide and
are summaries of the conclusions reached in selected legal rulings of counsel.
Annotations do not embellish or interpret the legal rulings of counsel which they
summarize and do not have the force and effect of law.” (Cal. Code Regs., tit. 18,
§ 5700.) Our Supreme Court explained in Yamaha Corp. of America v. State Bd. of

                                              11
Equalization (1998) 19 Cal.4th 1, 14, that the “deference due an agency
interpretation—including the Board’s annotations at issue here—turns on a legally
informed, commonsense assessment of their contextual merit.” Annotations are “not
controlling upon the courts,” but “do constitute a body of experience and informed
judgment to which courts and litigants may properly resort for guidance. [Citation.]”
(Ibid.)
              With the various sources of authority in mind, we will briefly outline the
current “change of ownership” legal theories regarding: (1) leasehold transactions;
(2) extensions of leases; and (3) the sale of property encumbered by a lease. With respect
to all three types of transactions, the question of change of ownership depends on the
duration of the lease. Understanding these scenarios is helpful for understanding the tax
ramifications in this case, where the long-term lessee agreed to extend the lease term an
additional 15 years and then purchased the property with the assistance of an outside
investor. In this case, we must decide whether there is a change of ownership when
property is purchased by a lessee having an original lease term of more than 35 years.
              i. Leases
              Section 61, subdivision (c), provides a change of ownership occurs by the
creation or termination of a leasehold interest in real property for a term of 35 years or
longer. Rule 462.100, subdivision (a), contains identical language regarding long-term
leaseholds. The Board and legal authority agree a change of ownership occurs because
the transaction transfers to the lessee (1) a “present interest,” (2) a “beneficial
ownership,” and (3) the “value equivalence” element. (See Pacific, supra, 1 Cal.4th at
pp. 167-168.) In short, all three elements described in section 60 are transferred from the
lessor to the lessee, who becomes the primary owner for property tax purposes.
              Our Supreme Court explained, “When parties enter into a lease they create
the legal relationship that governs their respective rights in the land, and either’s

                                              12
successor in interest will be bound thereby. When the parties are sophisticated
commercial entities of the type likely to sign leases for 35 or more years, such leases will
often confer substantial rights on the lessee, such as the right to develop or modify capital
assets, the long-term use or uses to which the land is to be put, and the like. A long-term
lease may also require the lessee to pay property taxes; indeed, the lease here imposes
that duty on plaintiff. In sum, the primary economic value of land encumbered by a lease
of such duration rests with the lessee; the lessor’s rights as a practical matter are limited
to receiving rental payments under a relationship the terms of which are fixed by prior
agreement for a time substantially equivalent to the duration of a fee.” (Pacific, supra,
1 Cal.4th at pp. 167-168, italics added.)
              To clarify matters, the Board created rules for when the leasehold interest is
for less than 35 years. Rule 462.100, subdivision (b)(1), provides the creation and
termination of a leasehold interest having an original term shorter than 35 years will not
result in a change of ownership. For a short-term lease, the primary economic value of
land remains with the lessor. Thus, only two of the three section 60 elements are
transferred to the lessee by the creation of a leasehold less than 35 years: The short-term
lease transfers to the lessee a “present interest,” and “beneficial ownership,” but not the
“value equivalence.”
              ii. Lease Extensions
              Nowhere in the statutory scheme or the Rules is the topic of lease
extensions discussed. As noted by Dyanlyn, the Board currently believes the question of
whether a lease extension triggers a change of ownership depends entirely on the duration
of the original lease (not the remaining term on the lease). The Board’s Advisory
Opinion (No. 09013291), dated May 27, 2009, is part of our record on appeal (hereafter
Advisory Opinion).
              The Board has issued several advisory opinions and property tax
annotations (hereafter Annotations) on the treatment of lease extensions. At the time of

                                              13
Dyanlyn’s transaction in 2006, there were two Annotations concluding the transaction of
extending a leasehold term to over 35 years would qualify as a change in ownership
(Annotation 220.0332 (July 13, 1981, December 9, 1988), and Annotation 220.0351
(December 24, 1991)), both Annotations were deleted December 2009.
              In 2009, the Board revised its opinion and issued a new Annotation
220.0357 (May 27, 2009), concluding the change of ownership question for lease
extensions depended on the term of the original lease: “If a leasehold was originally, or
at one time, for a term of 35 years or longer, and if a reassessment had already occurred
upon the lease’s creation or extension to a term of 35 years or longer, the extension of the
term back to 35 years or longer, when the remaining term is less than 35 years, does not
result in a change in ownership if there were no other material changes in the terms of the
lease made by the lease extension. However, if a leasehold term has at all times been
under 35 years, the first extension of the leasehold term to 35 years or longer results in a
change in ownership.” (Italics added.)
              The Board’s legal department issued the Advisory Opinion regarding
Annotation 220.0357, explaining why its earlier Annotations were incorrect and had been
deleted. The Advisory Opinion’s author, tax counsel Matthew F. Burke, explained there
are potentially two different lease extension situations. The first occurs where a lease
extension is made to a leasehold that has always been under 35 years. He referred to this
situation as an “under/over” because the lease was originally “under” 35 years and then
was extended to 35 years or longer (“over” 35 years). Burke reasoned there was no
change in ownership when the lease was first created because the lessor retained the
“value equivalence” component. “When the parties agree[d] to extend the leasehold term
to 35 years or longer for the first time, value equivalence [was] transferred from the
lessor to the lessee for the first time.” Burke opined this transfer must result in a change
of ownership because all three parts of the section 60 test are satisfied. The lessee
became the owner of the leased premises for property tax purposes.

                                             14
              Burke referred to the second type of lease extension as an
“over/under/over.” He explained this situation arises when the lease was originally
“over” 35 years, the mere passage of time dropped the lease term to “under” 35 years,
and then the parties negotiate to extend the lease to once again be “over” 35 years.
Burke opined this extension would not result in a change of ownership. “Consistent with
section 60 . . . the property underwent a change of ownership when the lease was first
entered into . . . [because] the lessee obtained a present interest and the beneficial use . . .
[and] the value equivalence. Thus, the lessee [became] the owner of the leased premises
for property tax purposes. Once the leasehold term drop[ped] below 35 years, the value
equivalence shift[ed] to the lessor, however, we have consistently taken the position that
. . . although the value equivalence shifts from the lessee to the lessor, there is no change
in ownership. This is because the lessor does not become ‘owner’ of the leased premises
for property tax purposes. . . . [T]he lessee remains the owner for property tax purposes . .
. unless and until the lease expires or the lessor otherwise transfers its underlying fee
interest in the property. [¶] If the lessor and lessee subsequently enter into a lease
extension at any time while the remaining leasehold period is under 35 years, the value
equivalence once again transfers to the lessee. However, the lessee has at all times
retained a present interest in and the beneficial use of the property . . . . A present interest
in and the beneficial use of the property were transferred to the lessee at the beginning of
the lease, and have remained with the lessee at all times. Thus no change in ownership
occurs. (Fn. omitted.)”
              The Advisory Opinion clarified it is “crucial to recognize” that when a
lease for 35 years or longer is created “the change in ownership based upon the transfer
of all three elements has already been captured” and the lessee becomes the owner for
property tax purposes. Burke explained “when only the value equivalence is transferred
in a later extension, there has not been a correlative transfer of the present interest and
beneficial use” because those elements were retained by the lessee.

                                               15
              In a footnote, Burke cautioned, “This opinion, however, may not be
interpreted to suggest that a lease extension under this specific situation could be entered
into with the intent of avoiding a reassessment upon a sale of the underlying fee interest
in the property by the lessor. In our opinion, such a transaction would be subject to the
step transaction doctrine” as discussed in the Shuwa case. This warning conveniently
leads us to the third category of transactions involving the sale of an underlying fee
interest in property encumbered by a lease.
              iii. The Sale of Property Encumbered by a Lease.
              Unlike lease extension transactions, the question of change of ownership
following the sale of property encumbered by a lease appears to depend on the
“remaining term” of the lease (not the original term of the lease). Section 62 lists several
“exclusions” and provides a change of ownership shall not include, “Any transfer of a
lessor’s interest in taxable real property subject to a lease with a remaining term
(including renewal options) of 35 years or more.” (§ 62, subd. (g).)
              This statutory exclusion was created because the task force and the
Legislature recognized that a property owner selling the underlying fee interest in
property encumbered by a 35-plus year lease would not be transferring to the new owner
the primary economic value of the land. The lessee retains ownership for property tax
purposes, having a “present interest,” “beneficial ownership,” and the “value
equivalence” due to the lease’s long duration. (See Pacific, supra, 1 Cal.4th at p. 168.)
              The legislative intent supporting the 62(g) exception is discussed in Pacific,
supra, 1 Cal.4th at pages 167 through 168, and Crow Winthrop Operating Partnership v.
County of Orange (1992) 10 Cal.App.4th 1848, 1855
(Crow Winthrop).) “[This exception] is consonant with the concern of the task force
report drafters that a transaction should not trigger reassessment unless it transfers the
interest of the party carrying the primary economic weight of the property. (Task force
rep., supra, at p. 40.) Such a determination also comports with commercial reality and

                                              16
public expectations, both subjects of concern to the drafters of the report. (See Id. at pp.
38, 41, 61.) The mischief a contrary rule could create is evident: for example, a rule
permitting reassessment whenever the fee changed hands in land subject to a lease with a
remaining term of 35 years could result in an enormous tax increase for a lessee that has
erected major capital improvements on the land and whose lease requires the lessee to
pay property taxes. The increase could occur merely because the lessor has sold that
interest to a third party—a transfer over which the lessee has no control.” (Pacific, supra,
1 Cal.4th at p. 168; Crow Winthrop, supra, 10 Cal.App.4th at p. 1855 [“it was clear the
drafters meant the term to include only those reservations in which the transferor retained
the beneficial use of the property”].)
              The Board’s interpretation of the statutory exception resulted in two rules,
Rule 462.100, subdivisions (a)(2)(A) and (b)(2)(A). The second rule contains similar
wording as the statutory exception, stating there is no change of ownership by “[t]he
transfer of the lessor’s interest in real property subject to a lease with a remaining term of
35 years or more, whether to the lessee or another party.” (Rule 462.100,
subd. (b)(2)(A).)
              We recognize the statutory exclusion (§ 62, subd. (g)) does not contain the
modifying phrase “whether to the lessee or another party” as stated in Rule 462.100,
subdivisions (b)(2)(A). However, the Board’s expanded interpretation of the exception is
correct in light of the case law and Advisory Opinion discussed above. Rule 462.100,
subdivisions (b)(2)(A) properly acknowledges a long-term lessee will “capture” primary
ownership of the property when the leasehold lasting more than 35 years is created.
Therefore, whether the property is purchased by a third party, or the lessee, the property
owner’s transfer of the underlying fee interest cannot be deemed a change of primary
ownership. The lessee retains primary ownership in either transaction.
              It appears the only appreciable difference occurring when the property is
purchased by the long-term lessee, as opposed to a third party, is the lessee obviously has

                                              17
control over the sale. We conclude this is a distinction that does not make a difference.
Our Supreme Court in Pacific, discussed the “mischief” that could result if it interpreted
the rules to permit reassessment whenever the fee changed hands to an outside third
party, because the lessee having “no control” over the transaction would be burdened by
an enormous tax increase. (Pacific, supra, 1 Cal.4th at p. 168.) However, the court did
not mean to suggest “lack of control” over the transaction was a necessary element for a
long-term lessee to avoid reassessment. The court’s discussion merely highlighted why it
was important to follow the task force’s recommendation to avoid “unwarranted
complexity by identifying the primary owner so that only a transfer by him will be a
change in ownership . . . .” (Task force rep., supra, p. 40.) The Pacific court determined
that when the lessee is the primary owner for property tax purposes, a sale of the
underlying fee interest in the property will not trigger reassessment because there has
been no change of ownership. (Pacific, supra, 1 Cal.4th at p. 168.)
              The Board’s first rule, Rule 462.100, subdivision (a)(2)(A), appears to be a
mirror image counterpart to the second rule. It provides a change of ownership occurs by
“The transfer of a lessor’s interest in taxable real property subject to a lease with a
remaining term of less than 35 years.” (Rule 462.100, subd. (a)(2)(A), italics added.)
We find this rule is problematic because it is not in sync with the case authority or the
Advisory Opinion. As we will explain below, Rule 462.100, subdivision (a)(2)(A ), fails
to recognize the distinction between a long-term lessee having a primary ownership from
a third party who does not.4 We are not bound to follow administrative rules, and for
purposes of this appeal, we will not.




4             The Board should consider adding a modifying phrase to accommodate
situations where the lessee is the primary owner and purchases the property encumbered
by a lease that was originally 35 years or more.

                                              18
               iv. Rule 462.100, subdivisions (a)(2)(A)
               We found no case authority supporting Rule 462.100(a)(2)(A). And in
light of Burke’s detailed and persuasive Advisory Opinion, we conclude the rule as stated
would not apply in “over, under” lease situation when there is a transfer of a lessor’s
interest in taxable real property to the long-term lessee, when the original term of the
lease was “over” 35 years. It is only through the passage of time that the remaining lease
term dropped “under” 35 years. We agree with the Board’s “consistent position” that
“although the value equivalence shifts from the lessee to the lessor [by the passage of
time], there is no change in ownership. This is because the lessor does not become the
‘owner’ of the leased premises for property tax purposes. [T]he lessee remains the owner
. . . .” (Fn. omitted.)
               To summarize, in the context of lease extension transactions, the Assessor
should not consider the passage of time as transferring primary ownership to the lessor.
The lessee is deemed to have retained primary ownership for property tax purposes
despite having a remaining term of less than 35 years. We find no logical reason why
this same rule should not apply in the context of a purchase transaction by a long-term
lessee. The section 60 test would be applied the same way: The lessee captured all three
section 60 elements when the long-term lease was first created. Whether the lessee
extends the lease or acquires the underlying fee interest, the lessee remains the primary
economic owner before and after the transactions. “The lessee has at all times retained a
present interest in and the beneficial use of the property . . . . Thus, no change in
ownership occurs.”
C. Analysis
               In the case before us, there are two transactions at issue. In the first
transaction the property owner and Golden Westminster agreed to extend the lease by




                                              19
15 years (creating a remaining term of 45.5 years). Under the Board’s current Annotation
regarding lease extensions, this “over, under, over” scenario would not result in a change
of ownership because the original lease was for a term exceeding 35 years.
              In the second transaction, the owner of the subject property sold its
fee interest to Dyanlyn. Pursuant to the 62(g) exception, the sale would not be ordinarily
considered a change of ownership because the property was encumbered by a long-term
lease.
              Thus, neither transaction standing alone was a change of ownership
triggering reassessment. However, the Assessor determined the two transactions viewed
together were suspect because (1) two-thirds of Dyanlyn’s partnership was comprised of
long-term lessees and they could have manipulated the lease to unfairly take advantage of
the 62(g) exception, and (2) when the transaction took place back in 2006, the Assessor
was operating under now-deleted Annotations holding the lease extension past 35 years
would trigger reassessment.
              The sole question we must decide de novo on appeal is whether the two
transactions, viewed together, were a sham to avoid reassessment of property taxes. As
we will explain, the answer is no.
              i. Step Transaction Doctrine
              The Assessor reassessed the property on the theory the property owner and
Dyanlyn took multiple steps to avoid triggering reassessment. The Assessor decided step
one was an extension of the lease to a term beyond 35 years, and step two was the sale of
property encumbered by a long-term lease, falling under the 62(g) exception to change of
ownership. The bulk of the briefing in this case is devoted to whether the exception
should be overridden in this case pursuant to the step transaction doctrine. (See Shuwa,
supra, 1 Cal.4th at pp. 1648-1649.)
              “In a case such as this, where the propriety and necessity for multiphase
transactions is challenged, the ‘step transaction doctrine’ has been applied to determine

                                             20
whether the transaction should be treated as a whole or whether each step of the
transaction may stand alone. The ‘step transaction doctrine’ is a corollary of the general
tax principle the incidence of taxation depends upon the substance of a transaction rather
than its form. [Citation.] Although the concept is not entirely alien to California
jurisprudence, the doctrine was developed and is primarily utilized in the federal courts.
[Citations.]” (Shuwa, supra, 1 Cal.App.4th at pp. 1648-1649.)
               “In Shuwa, supra, . . . the court set forth the history of the step transaction
doctrine as a ‘corollary of the general tax principle the incidence of taxation depends
upon the substance of a transaction rather than its form. [Citation.]’ [Citation.] Three
basic tests have been developed for application of the step doctrine: (1) the ‘end result
test,’ in which purportedly separate transactions ‘will be amalgamated with a single
transaction when it appears that they were really component parts of a single transaction
intended from the outset to be taken for the purpose of reaching the ultimate result . . .
[citations]’ [citation]; (2) the ‘interdependence test,’ requiring an evaluation of ‘“whether
on a reasonable interpretation of objective facts the steps [are] so interdependent that the
legal relations created by one transaction would have been fruitless without a completion
of the series . . .” [citations]’ [citation] (in other words, the analysis is of the relationship
between the steps and asks whether one step would have been taken without any of the
others [citation]; and (3) the ‘binding commitment test,’ requiring that if one transaction
is characterized as a first step, there must be a binding commitment to take later steps.
[Citation.] The court in Shuwa applied all three of the tests and found they were all
satisfied by those facts. The court did not comment on whether the use of the tests may
be made in the alternative and whether satisfaction of less than all tests is enough to find
a step transaction exists.” (McMillin, supra, 31 Cal.App.4th at pp. 554-556.)
               The McMillin court, relying on federal authority, determined only one test
need be satisfied. (McMillin, supra, 31 Cal.App.4th at p. 556.) The court in King
Enterprises, Inc. v. United States (Ct.Cl. 1969) 418 F.2d 511, 517, held that although

                                                21
there are real differences between the step transaction tests, “each is faithful to the central
purpose of the step transaction doctrine; that is, to assure that tax consequences turn on
the substance of a transaction rather than on its form.”
              If the long-term lessee (Golden Westminster) had alone purchased the
property, this case would be much simpler. There was no change of ownership by either
the lease extension (step 1) or the purchase (step 2) when viewed together or apart. A
lessee captures all three section 60 elements by creation of a lease lasting more than
35 years. Thus, the partners of Golden Westminster became primary owners for property
tax purposes when the lease was created in the 1970s. Regardless of whether the lease
was extended, the lessor’s transfer of its remaining fee interest in the property to the
long-term lessees would not be deemed a transfer of primary ownership for property tax
purposes. The passage of time does not serve to defeat the lessee’s role of primary
owner. Thus, because both step 1 and step 2 would not serve to avoid reassessment with
respect to the lessee (Golden Westminster), there would be no rational basis to apply the
step transaction doctrine (if the lessee alone purchased the property).
              Likewise, if the new investor, Sechelt, had alone purchased the property
from the owner there would be no change in ownership issue. Simply stated, Sechelt
purchased the lessor’s interest in property encumbered by a lease lasting more than
35 years. This transaction falls squarely within the 62(g) exception. Moreover, as to
Sechelt, the record supports the conclusion it was involved in only one step, i.e., the
purchase. It was undisputed Sechelt was not a party to the pre-existing leasehold
between the lessee and lessor. Sechelt could not control the leasehold and played no role
in extending the lease. The evidence showed Golden Westminster did not have a
particular entity in mind when it extended the lease to make the property more attractive
to outside investors. The step transaction doctrine applies to transactions involving
multiple steps, not just one, as would be the case if Sechelt was the sole purchaser.



                                              22
                We appreciate the Assessor believed the transaction in this case was
suspicious because the entity purchasing the property was a consortium of an existing
long-term lessee and a new investor. Golden Westminster, unable to afford the property
on its own, admitted the lease was extended, in part, to attract an outside investor. And
Sechelt clearly benefitted from becoming partners with long-term lessees because it could
ride on the coattails of those already possessing “ownership” for property tax purposes.
Unlike the Assessor, however, we do not consider the business deal to be a scam to avoid
reassessment. Applying the step transaction doctrine, we conclude the unusual
partnership arrangement does not justify overriding application of sections 60 and 62
(particularly when there would be no reassessment if the property was purchased by only
the parties owning a majority share (75 percent)).
                We turn first to the end result test. This test requires evidence steps 1 and 2
were really component parts of a single transaction intended from the beginning to reach
the end result of avoiding reassessment of property taxes. The end result test is not
satisfied unless there is evidence all the parties shared the same ultimate goal. “The end
result test and the binding commitment test both appear to require the same parties to
have been pursuing a related intent throughout the steps of the transaction. [Citation.]”
(McMillin, supra, 31 Cal.App.4th at p. 559.) There is no evidence Sechelt participated in
or encouraged the lease extension. To the contrary, the lease was lengthened to attract
any new investor, not specifically Sechelt.5 Because it cannot be said all the parties in
the transactions shared the same goal “from the beginning,” the end result test is
inapplicable.



5             The Assessor focuses on the close timing between the two steps as proof
Sechelt was involved early on in the transaction and suspicious activity. The Assessor
has confused proof with speculation. While timing is a factor to be considered, it must
relate to whether the transactions in question signify a related intent among the
participating parties.

                                               23
              The interdependence test also does not apply. The “interdependence” test
looks to whether the actions are “‘so interdependent that the legal relations created by one
transaction would have been fruitless without a completion of the series.’ [Citations.]”
(Shuwa, supra, 1 Cal.App.4th at p. 1651.) The Assessor argues, “Clearly all of the
transactions which took place in December 2006 were done for the ultimate purpose and
goal of allowing . . . the tenant/lessee to exercise its option to buy-out the ground lease,
which is, in fact, what ultimately happened.” It concludes the steps were interdependent
because standing alone they would not have the same legal effect of facilitating a buy out.
              This argument misstates the test. Each step must be evaluated to determine
if it had an independent meaning or if it would have been fruitless without completion of
the other steps. In cases such as Crow Winthrop, there was clear evidence one step of the
transaction had no purpose other than to avoid reassessment. That case involved a sale of
the property and then a lease back to the seller. (Crow Winthrop, supra, 10 Cal.App.4th
at p. 1856.) The court reasoned, “The leases had no independent meaning—they were
clearly the determinative factor in completing the sale . . . without incurring a
reassessment of this extremely valuable piece of property.” (Id. at p. 1858.) The prior
owner had been operating without the necessity of setting up leases, and the leases were
not consummated until all other aspects of the sale were completed. The court
determined the lease back arrangement was created solely to sidestep reassessment of the
property.
              Similarly, in the Shuwa case, the court determined the two sellers and
single buyer of a property devised an elaborate three-step process to achieve only one
purpose, Shuwa Investment Corporation’s (Shuwa’s) acquisition of ARCO Plaza. The
two sellers were partners. One partner sold Shuwa its 50 percent partnership interest, the
partnership was then liquidated and each received a 50 percent interest distribution in the
ARCO Plaza. Shuwa then purchased its former partner’s interest in the property.
“Shuwa wanted the entire Plaza; a one-half interest through the partnership did not

                                              24
accomplish its purpose and was but a means to buy the remaining interest held by Bank
of America. And that latter purchase ‘was only necessitated by the existence of the prior
two steps to effectuate Shuwa’s desire for all of the property.’ [Citation.] Thus, ‘each
individual step would have been useless without a completion of the series . . . .’
[Citation.]” (Crow, supra, 10 Cal.App.4th at p. 1857.) The court refused to “adopt the
subterfuge” and determined the transaction must be treated as a whole.
              In the case before us, there was evidence step one, the lease extension, had
independent economic substance. The lessee desired an additional 15 years to utilize its
buildings and improvements on the property, to collect rent, and improve its profit
margin. The transaction served a valid purpose unrelated to the goal of acquisition and
was not a fruitless act. Indeed, the lessee bound themselves to the terms of the new lease
regardless of whether they could later utilize the buy-out provision. It is undisputed the
ground lease is still valid under the new ownership. Accordingly, we do not find the two
steps interdependent because the lease extension (step one) would have been taken by the
lessee without the second step (in the event they had not found an outside investor).
              The final test, the binding commitment test, was not utilized by the Board
or trial court. We agree it does not apply because this case does not involve a series of
transactions spanning several years. (Associated Wholesale Grocers, Inc. v. U.S. (10th
Cir. 1991) 927 F.2d 1517, 1522-1523, fn. 6 [binding commitment test seldom applied].)
It rejected the “taxpayer’s claim that ‘the step transaction doctrine is inapplicable where,
. . . there are valid business reasons for the intermediate steps.’” (Id. at p. 1526.)
D. Assessor’s Arguments
              In its respondent’s brief, the Assessor discusses why the sale of a fee
interest is generally considered a change of ownership unless an exclusion applies. It
recognizes the 62(g) exception would apply but argues the Legislature did not intend for
the exclusion to apply in this case, i.e., when the sale is to a long-term lessee having
“control” over the sale transaction. Its reliance on the Pacific case to support this

                                              25
contention is misplaced. The Pacific court described the legislative intent to designate
one primary owner for property tax purposes. (Pacific, supra, 1 Cal.4th at p. 168.) It
determined that when a lessor sells property encumbered by a long-term lease, the lessee
possesses primary ownership and there is no change in ownership. To support this rule,
the court recognized reassessing property taxes every time the fee interest was sold to a
third party would be unfair to the party possessing the primary ownership interest
because he or she lacks control over the sale. As we explained earlier in this opinion, the
court did not conclude the Legislature intended a different change of ownership test
focused on whether the primary owner lacked or held control over the transaction. The
court merely highlighted the unfairness to be avoided by reassessing property when the
primary ownership interest has not been transferred by the transaction. This argument is
just one example of several in which it appears the Assessor is attempting to stretch the
rules to preclude a long-term lessee from entering into legitimate multi-party transactions
for fear of being reassessed. Using the statutory exception is not automatically suspect
behavior.
                                            III
              The judgment is reversed. The matter is remanded to the trial court with
directions to enter judgment for Dyanlyn. Appellants shall recover their costs on appeal.



                                                  O’LEARY, P. J.

WE CONCUR:



FYBEL, J.



IKOLA, J.


                                            26
