DC council authorizes real property tax freeze for downtown office properties repositioned for non-residential use

Downtown Washington, DC office properties repositioned for alternative uses may be entitled to significant real property tax benefits under the Downtown Activation Conversion Program, which aims to address high office vacancy by adapting underutilized inventory.

The DC Council first enacted legislation in September 2022 authorizing tax abatements for office-to-residential conversions. On June 25, 2024, the Council enacted new legislation authorizing tax assessment freezes for downtown office properties repositioned for non-residential use.

Background: focus on residential conversions

The District’s office vacancy rate rose to 22.4 percent in Q2 2024 according to CBRE, reflecting over 500,000 square feet of occupancy loss on top of record vacancy figures recorded throughout 2023 and Q1 2024. The District is not alone, as hybrid work arrangements have pushed office vacancy rates in numerous cities to new heights. But the District’s challenges are unique, with federal agencies looking to reduce their office footprints as federal employees’ remote work rates remain disproportionately high. Class B and C buildings have particularly suffered as employers have “fled to quality,” seeking higher-grade spaces to attract workers into the office, continuing a yearslong trend.

With high vacancy rates undermining the local tax base and presenting challenges for downtown property owners and neighboring businesses – especially retail – the District government has pursued solutions mainly focused on addressing housing shortages. In September 2022, the District authorized up to 20 years of tax abatement and loosened obligations to comply with the Tenant Opportunity to Purchase Act (TOPA) for downtown office properties converted to residential use, provided that eligible properties meet specified affordability requirements. The Department of Buildings followed the next month by amending regulations to expand the range of downtown buildings eligible for residential conversion as of right by loosening building requirements typically applicable to residential properties. However, the high costs of residential conversions has left many developers skeptical that these initiatives will significantly affect the local market.

2024 tax freeze legislation: supporting diverse conversions

The June 2024 legislation targets a broader array of adaptive reuses to address the downtown office vacancy problem. The legislation provides properties “undergoing or planning to undergo a repositioning” with a period of 15 years without property tax increases, defining “repositioning” broadly to mean:

a construction, reconstruction, alteration, or renovation to a property with a minimum of 50,000 square feet that results in the conversion of the property from a primarily office use to a use that is not residential or in an upgrade in the class of the office space to class A from a class below class A.

The legislation intends to mitigate the costs of upgrading office properties, empowering downtown landlords to capitalize on tenants’ “flight to quality.” However, the legislation would also provide property tax relief to developers converting office properties into hotels, medical office buildings, and lab spaces, among other potential uses.

The legislation defines the “base year” after which the 15-year freeze period commences as “the real property tax year in which the tax incentive is certified” by the Mayor, rather than the year in which the repositioning is completed, freezing an eligible property’s taxes based on a lower value. The freeze will apply while the repositioning is underway, affording the property owner the benefit of lower taxes during the construction period, when cash flows derived from the property may be limited. If repositioning activities do not commence within three years of certification, the property owner must pay the taxes that would have been due during the previous three years absent the freeze.

Conclusion: forthcoming rulemaking

The new legislation gives the Mayor substantial discretion to implement its provisions by (1) establishing eligibility requirements, (2) creating a selection process, (3) identifying eligible properties, and (4) certifying when a repositioning has been completed. For example, the Mayor will decide whether eligibility for the tax freeze will be conditioned upon compliance with the District’s First Source Law, which requires that recipients of local government assistance agree that at least 51 percent of newly hired employees be District residents. As the Mayor develops rules to implement the new legislation, developers, investors, real estate industry and community development associations, and other stakeholders may want to consider how the rules might affect potential projects and contact District officials with their concerns.

To learn more about the new legislation and the District’s efforts to stimulate local real estate investment, please contact the authors of this alert, your DLA Piper relationship partner, or any member of our Real Estate team.