San Francisco’s Commercial Vacancy Tax: Have You Reported?

The last day of February marks the end of the first reporting period for San Francisco’s new Commercial Vacancy Tax. The tax was approved in March of 2020 by more than 70% of San Francisco voters, and is codified in Article 29 of the San Francisco Business and Tax Regulations Code, sections 2901 through 2911.

The measure, voted in just before the onset of the COVID-19 pandemic, was based on the premise that “retail vacancies occur when a property owner or landlord fails to actively market a vacant retail storefront to viable commercial tenants and/or fails to offer the property at a reasonable rate. Retail vacancies may persist as property owners and landlords hold storefronts off of the market for extended periods of time or refuse to offer the space for a reasonable market rate.”

The tax was championed by Supervisor Aaron Peskin, who accused landlords of intentionally keeping properties vacant while waiting for higher-paying tenants in a booming economy. In proposing the measure, Peskin identified commercial spaces in North Beach he claimed were being intentionally kept vacant and were contributing to neighborhood blight. The measure fails to define what is a “reasonable market rate,” but certainly seemed designed to put the City’s finger on the scales in favor of existing and potential commercial tenants in their lease negotiations.

What Properties Could Be Taxed?

The tax applies to “Taxable Commercial Spaces,” which is defined as any street-facing ground floor of any building or structure in one of the thirty-two Named Neighborhood Commercial Districts (NCD) or Named Neighborhood Commercial Transit Districts (NCT). These districts, a map of which is available on the San Francisco Treasurer’s website, include a number of neighborhood commercial corridors such as Mission Street, Irving Street, Clement Street, the Castro, and Haight Street. Chinatown and Union Square, both of which are in Peskin’s district, are excluded from the measure.

What is Required of Commercial Property Owners and Tenants?

The measure requires that every owner, lessee, and sublessee of a Taxable Commercial Space in the City file a Commercial Vacancy Tax Return, which is available online. The return must be submitted and paid on or before February 28, 2023. The tax is due if the commercial space is “vacant” which is defined as being “unoccupied, uninhabited, or unused” for more than 182 days in a tax year, whether consecutive or not. The measure does not define “occupied,” “inhabited,” or “unused,” which adds a significant amount of ambiguity as to what is technically “vacant.”

The vacancy tax is payable by either the owner, the tenant, or the subtenant, depending on who caused the commercial space to be “kept vacant” for 182 days in the tax year. If the commercial space is not leased, then the owner is liable. If it is leased, the tenant or subtenant is liable. While it is unclear, no tax appears to be due if the commercial property is vacant for more than 182 days in a year, but leased for part that period. Landlords who have vacant storefronts who may be subject to the tax, should consult with an attorney to craft a proper lease provision that averts or properly allocates the tax.

In calculating the 182-day period, commercial property is not considered “vacant” when the owner or tenant is applying for a permit or a conditional use application. The owner or tenant also has an additional year following the issuance of the first building permit, to complete construction before the 182-day clock starts ticking. In addition, any two year-period following an incident where the property is damaged and made uninhabitable or unusable due to fire, natural disaster, or other catastrophic event, is not counted towards the vacancy period.

How Much Tax Is Owed?

The amount of tax is based on the size of the vacant storefront of the commercial property and the amount of time the commercial property has sat vacant. For the 2022 tax year, the amount is $250 per linear foot of street frontage; for the 2023 tax year it is $500 per linear foot; for each year thereafter, the amount is increased to $1,000 per linear foot.

What Impact Has COVID-19 Had on the Tax?

The stated purpose of the vacancy tax “is to stimulate the rehabilitation of long-term retail vacancies, and, in turn, to reinvigorate commercial corridors and stabilize commercial rents, thereby allowing new small businesses to open and existing small businesses to thrive.” While the tax has a number of exemptions, notably, there is no exclusion for a recession. While the City put the tax on hold for its first year based on COVID, the pandemic’s impact on commercial property vacancies is still being felt. While it is well-documented that the work-from-home trend has impacted the City’s downtown retail, the financial district and Union Square are exempted from the tax. Commercial corridors in the City’s neighborhoods that are subject to the tax, and which would seemingly not be impacted by the work-from-home trend, are also far from “thriving.” Some of the pre-pandemic factors that caused a downturn in neighborhood retail business, including online retail, still exist. In addition, there are now several post-pandemic factors adding to the vacancy problem, including San Francisco’s well-documented problems with street conditions including crime, filth, drug dealing and open drug use, and homelessness. These impact some small businesses’ ability to attract customers, and their landlords’ ability to rent out their commercial spaces. For example, one stretch of Mission Street, from 19th to 30th streets–a corridor subject to the measure–now has more than 70 commercial vacancies.

Adding to the problems, many commercial tenants shuttered their businesses during COVID, adding to the vacant commercial stock. Landlords are now faced with having to fill their commercial spaces in a market with a larger supply of commercial space, and fewer prospective tenants. While these factors may result in the “reasonable market rent” envisioned by the tax’s drafters, any landlord will be reluctant to lock themselves into a long-term lease at a low rent, especially if it will not cover the landlord’s debt service. A long-term lease, at what may be the bottom the market, also devalues the property–a factor if the landlord has any intention of selling. Long-term leases can also limit a landlord’s ability to develop the property. San Francisco’s new Housing Element, which allows mid-rise apartment buildings along some of the commercial corridors subject the tax, enacted to meet state-mandated housing goals, may make some properties more valuable development opportunities if they are empty of tenants.

What Should Landlords and Tenants Do If Faced With the Vacancy Tax?

As described above, is likely that some landlords will see paying the tax for a year or two, rather than tying up their property in a long-term lease, as the lesser of two evils. While it may not work for many landlords, a third option may be short-term “pop up” leases that occupy the property for at least half of each year. Parties considering such arrangements should consult with a real estate attorney to ensure their leases address issues specific to these types of short-term leases, including issues with delivery, insurance, and maintenance.

The measure does not require that a property be leased to be “occupied,” and its vague definition of “vacant” also allows some room for a landlord seeking to avoid the tax by using it in conformity with San Francisco Planning Code. A landlord considering exploring these types of options should consult with a qualified land use attorney to ensure that their contemplated use of the property is lawful and averts the new tax.

If you would like to learn more about the application of Article 29 of the San Francisco Business and Tax Regulations Code to your property, you should contact the experienced attorneys of Zacks & Freedman for guidance. Contact us at your convenience to request a consultation.

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