A state judge has ruled that the city’s Residential A tax classification is unconstitutional, a decision that possibly could leave the city scrambling to make up lost money this year and needing to find millions in revenues in subsequent years.

City Corporation Counsel Donna Leong said city officials maintain that they are in the right, and she indicated she will appeal the decision to either the state Intermediate Court of Appeals or the Hawaii Supreme Court.

The city’s 2-year-old Residential A classification taxes properties valued at $1 million or more but that do not carry home exemptions that are granted on properties that house owner-occupants.

The new tax was approved 7-2 by the City Council in 2013. The Caldwell administration subsequently submitted a budget that taxed Residential A properties at $6 per $1,000 of assessed value, a hefty 71 percent higher than the $3.50 per $1,000 of value that standard residential properties are taxed. The Council approved the budget with the higher rate.

Tax Appeal Court Judge Gary W.B. Chang, in an oral decision, ruled Monday in favor of a group of about 20 property owners with parcels designated as Residential A properties who argued that they have been arbitrarily taxed based on the properties’ value.

Residential A opponents have also argued that the new classification poses a particular hardship on an island where a home valued at $1 million increasingly is not considered luxury. Local residents who live on the $1 million-plus properties they own but have not obtained home exemptions also have opposed Residential A.

Supporters of Residential A, including Mayor Kirk Caldwell and City Council leaders, argue that creating the category makes it easier for them to shield longtime residents from higher tax bills.

City tax appeals cases based on Residential A arguments have been routinely dismissed because city officials have argued that only assessed values, and not the tax class, can be contested.

There are currently about 8,800 Residential A properties on the city’s books. Based on the latest valuations certified by the city in January, this year the city is expected to collect an estimated $39.3 million in revenues from Residential A property owners above what they would pay if taxed at the lower residential rate.

Ray Kamikawa, attorney for the Residential A owners who brought the suit, said it’s improper for the city to set up more than one tax classification for residential properties.

“Residential use is residential use,” said Kamikawa, a former director of the Department of Taxation and now a partner in the law firm Chun Kerr LLP. “There can only be one classification for residential. The way the ordinance works, (the city) is not permitted to set up a subset of residential based on a $1 million-based value and whether a homeowner exemption is granted for that property. And the court agreed with that view of the ordinance.”

Additionally, the Commerce Clause of the U.S. Constitution prohibits states and municipalities from discriminating against interstate commerce, and the Residential A tax class discriminates against nonresidents, Kamikawa said.

An owner who has a property valued at $999,999 pays $2,500 more in taxes once that value jumps to $1 million, he said.

Oahu property owners pay taxes twice each fiscal year, the first time in August and the second time in February. (The city fiscal year runs from July 1 through June 30.)

“The county will have to decide whether to refund the payments already made (in August) by the complaining Residential A owners in our lawsuit,” Kamikawa said. Regarding the February bills, he said, the city will need to decide whether to reclassify all Residential A properties back to the general residential class or cancel the current assessments.

City officials, however, disagreed with Kamikawa.

Tax assessments are set for the year, and only those who filed an appeal by the annual filing deadline can be eligible for an appeal, said Gary Kurokawa, the city’s deputy director of budget and finance.

“This tax appeal case is affecting only 29 assessments. That’s it,” he said, adding that it has not been determined how much revenue would be lost if those properties were taxed at the lower rate of $3.50 per $1,000 of value.

Kurokawa also disputed Kamikawa’s claim that the city will need to rework the February bills for all Residential A property owners. “The taxes are for the whole year; February is just the second half-payment,” he said. “Whatever was assessed stands through the whole year.”

Kurokawa declined to speculate about what will happen to Residential A next fiscal year, adding that the city believes it has a solid case for appeal.

Leong, the city’s top attorney, agreed. “The city believes the Residential A classification is legal and constitutional and that there is a rational basis for the classification,” Leong said in a statement. “The city also believes that the court should give deference to the City Council’s policy decisions in tax matters, and that the law should be upheld based on such deference.”

Different classifications for real property tax assessment have been used by municipalities across the United States, Leong said.

“The city has a legitimate interest in local neighborhood preservation, continuity and stability, and the creation of Residential A has helped facilitate these goals.”

Chang’s ruling came days after the Residential A dispute became a political football during a mayoral candidates forum where Caldwell and challenger Charles Djou voiced different opinions on the topic.

Djou said Residential A was a mistake and that he would work toward eventually eliminating it. Caldwell said the new category was needed to shield the average, local homeowner from needing to pay more for city services, but that he is willing to consider tiered, or graduated, rates for properties valued at $1 million or more.