Early in the 1970's, California taxpayers
revolted against escalating property taxes and, through the voter
initiative process, passed Proposition 13, a Constitutional
amendment which severely limited annual property tax increases.
Prior to its passage, assessed value usually equaled fair market
value. This caused large property tax increases whenever real
estate prices rose. Proposition 13 was enacted to prevent
long-time home owners from suffering tax increases, and possibly,
the loss of their home if they could not pay the higher taxes.
Under California's Proposition 13, property taxes may not be increased more than 2% annually over the assessed value of the previous assessment year, unless a reappraisal of the property to full cash value is caused by (1) a change in ownership ("CIO") not otherwise exempted by statute; (2) new construction not exempted by statute; or (3) a decline in value due to damage or construction. California Constitution, Article XIIIA, §2(b); R&T Code §51.
Many people believe that Proposition 13
protects them unless they "sell" their property to
someone else. Unfortunately, Proposition 13 offers less
protection than one would think.
With the proliferation of "do it yourself" form books and software on the market, increasing numbers of individuals are forming their own corporations, partnerships and trusts, and transferring real property to these entities, without legal assistance. While the transaction guides can assist you in relatively uncomplicated undertakings, you are using them at your own peril. If you structure these transactions, it is critical to understand the property tax consequences. Many straight-forward estate planning and business transactions may, inadvertently, trigger a property tax reappraisal.
If you engage in estate planning or business
transactions involving California real estate, you must
understand when a property tax reassessment will occur.
Just as important, you should be cognizant of when exclusions
from reassessment could apply and how to timely file for them.
A CIO is defined broadly under California's Revenue and Taxation Code ("R&T") §60 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 interest." The determination of when a CIO occurs is critical. The following transfers are generally excluded from the definition of CIO:
1. Transfers where owners remain the same and
have the same percentages of ownership before and after the
transfer. A transfer that changes the method of holding title but
not the identity and proportion of title does not trigger a CIO.
[See R&T Code 62(a)(1) concerning transfers of property or
R&T Code 62(a)(2) for transfers of property interests];
2. Interspousal transfers (R&T Code §63).
Note: There has been some uncertainty whether or not the interspousal transfer applies to transfers of interests in legal entities under Sections 64 (c) and (d), discussed below. The State board of Equalization ("SBE") has proposed a rule permitting the interspousal exclusion for these transfers. Property Tax Rule 462.180(d)(2). Unfortunately, county assessors are not bound by SBE rules.
3. Parent/child transfers: personal residence
plus $1,000,000 of "full cash value" (assessed value,
not fair market value) of other undivided interests in property
(R&T Code §63.1). The parent/child exclusion applies only to
undivided interests, not to transfers of interests in
legal entities (such as transfers of partnership interests,
shares of stock, or memberships in LLCs). Interests in trusts,
however, are excludable under R&T Code §63.1(b).
Note: The parent/child exclusion applies to transfers to grandchildren from grandparents on or after March 26, 1996, where all parents (including step parents) are deceased as of the date of sale or transfer. Where the child's marriage is dissolved, the child has not remarried, and the child is deceased, the grandchild exclusion will apply. Amendments to R&T Code §63.1. A daughter-in-law or son-in-law who is a surviving spouse of a deceased child (where the marriage has not been "terminated by divorce" prior to the child's death) is within the definition of "children" only until re-marriage. R&T Code §63.1.
4. De minimis transfers where the interest in
the real property is less than 5% of fair market value of the
total property and if the aggregate amount transferred is less
than $10,000 of fair market value (R&T Code §65.1).
A transfer of property from an individual to a legal entity, such as the contribution of property by a shareholder to a corporation, or by a partner to a partnership, is normally treated as a CIO [R&T Code §61(j)], unless (1) the ownership interests remain the same before and after the transfer [R&T Code §62(a)(2)]; or (2) the transfers are among affiliated corporations (Rule 462.180). Another CIO will normally result if a corporation or partnership distributes property back to the shareholder or partner (unless R&T Code §62(a)(2) applies). [R&T Code §61(j)].
As long as the ownership interests remain the
same before and after the transfer, the formation of an entity
will not result in a CIO under R&T Code §62(a)(2). After the
entity is formed, the general rule of R&T Code §64(a)
provides that the transfer of interests in the entity do not
trigger a CIO, unless:
(1) The transfer is a transfer of stock in a
cooperative housing corporation [R&T Code §61(h)];
(2) A person or entity (including a trust),
obtains direct or indirect control of more than 50% of the
ownership interests or obtains a majority ownership interest in
an entity. The purchase or transfer may be for less than 50%, as
long as it results in a shift of control by the individual or
entity. [R&T Code §64(c)].
There is no CIO when --
(a) a majority interest in a partnership
obtains all remaining ownership interest [R&T Code
§64(c)(2)]. Note: corporations do not qualify under this
rule;
(b) the transfers of real property are between
or among affiliated corporations, including those used to achieve
corporate reorganization. (Rule 462.180);
(3) On or after March 1, 1975, when a property
is transferred to an entity which is not a CIO under R&T Code
§62(a)(2), then the persons holding the ownership interests
immediately after the transfer are the "original
co-owners." Where any of the original co-owners transfer
more than 50% of the ownership interests (in one or more
transactions), a CIO of the entity's real property occurs, and
the property will be reappraised [R&T Code §64(d)].
Note: A transfer that results in a change of control of the entity is subject to reappraisal under 64(c) rather than 64(d).
Thus, the addition or deletion of interests in an entity does not constitute a CIO, except when there is a change in control, or a transfer of more than 50% interest of the "original co-owners." Keep in mind that the parent/child exclusion does not apply to avoid a CIO in these circumstances, and although the interspousal exclusion should apply, it is best to confirm this position with the county assessor where the property is located before taking action.
Sometimes, it is beneficial to trigger a CIO. If property has been recently purchased or its fair market value has not significantly increased, causing a current CIO could prevent a future tax reassessment. For example, assume a trust will distribute property to the remainder beneficiaries as tenants in common when the current life beneficiary dies. The remainder beneficiaries want to form a Limited Liability Company to hold their interests. If an LLC is formed by the trust currently and if there is a CIO (by slightly altering the percentage of beneficial interests), then the current fair market value will be used for assessment purposes. A later termination of the LLC in which all members receive their proportionate share will not cause a CIO.
If, however, there is not a current CIO, then
the reassessment will occur when the trust distributes the
property, which might occur 20 years later, at which time the
property may have appreciated greatly in value. Remember:
the parent/child exemption may prevent a CIO, so consider these
alternatives carefully.
Generally, when a joint tenancy interest is
transferred from one owner to another owner in the creation,
transfer, or termination of a joint tenancy, a CIO occurs
[R&T Code §61(e), 65(a)], and the interest that is thereby
transferred from one owner to another owner is reappraised, with
the following qualifications and exceptions (R&T Code §65):
In a joint tenancy creation, transfer, or termination, always assume a CIO will occur, unless you can apply a specific exemption. If you own property and add one or more individuals to the title as joint tenants ("transferees"), you will not trigger a reassessment, as long as you remain one of the joint tenants. R&T Code §65(b). If the other joint tenants transfer their title back to you, terminating the joint tenancy, there is not a CIO because you were the "original transferor" of the joint tenancy interests. R&T Code §65 (d). However, if you transfer all of your joint tenancy interest to the transferees, a 100% CIO will result. R&T Code §65 (c). Although these results appear logical, problems result in the situation where two unrelated individuals purchase property together and hold title in joint tenancy (see example 12, of Part II).
The joint tenancy CIO rules are vague, and can
be difficult to apply. Verify the affect of Proposition 13 on the
transaction with your county's assessor before recording a deed.
Often, the assessor will provide you with a written opinion
regarding Propositions 13's effect on your proposed transaction.
The Preliminary Change of Ownership Report Form required to be filed with real property transfer documents should explain clearly why the transfer should be excluded from a CIO.
When a CIO occurs within an entity, the entity is required to file a change in ownership statement with the SBE. Discovery of a CIO that was not reported will result in escape or supplemental assessments for all tax years from the CIO to the present, as well as possible penalties.
In order to claim the parent/child exclusion of
Section 63.1, the transferor must file a parent/child exclusion
form with the county assessor, and list the transfer and the
amount of the exemption that the transferor is applying to the
transfer.
If a Notice to Re-Assess the Property is
issued, you must first pay the tax, then file a Claim for Refund.
You must also pay the increased property taxes during the time it
takes to resolve the issue, which can take years.
The SBE issues "Letters to
Assessors", intended to provide assessors with uniform
instructions in the assessment of property for taxation. The SBE
also provides written responses, referred to as
"Correspondence", to specific questions from assessors,
legislators, and practitioners. The letters to assessors are
entitled to "considerable weight" (Dreyer's Grand
Ice Cream, Inc., v. County of Alameda, 178 CA3d 1174, 1183;
224 Cal. Rptr. 285 (1986) (the courts, rather than the
administrative agencies, have final responsibility for
interpretation of the statute). The Correspondence is only
advisory. Thus, the SBE opinions are not binding upon the county
assessors.
Different counties may not always be uniform in their treatment of property tax issues in unclear cases. Also, some municipalities impose transfer taxes on real property transfers, and the standards to determine whether the transfer tax applies are not necessarily the same as those applied by county assessors for property tax purposes. Caution dictates that you should first obtain a written determination from the tax assessor that your transaction will not cause a reassessment, prior to taking any action.
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**NOTE: The information contained at this site is for educational purposes only and is not intended for any particular person or circumstance. A competent tax professional should always be consulted before utilizing any of the information contained at this site.**