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Transferring Real Property: How to Avoid an Unexpected Tax Hike in California

So, you’ve included your property in a revocable trust and feel pretty good that your Malibu, Calif., home, San Diego office building and family cabin in Lake Tahoe, Calif., will transfer down to your heirs rather seamlessly. But what about property taxes? In California, property taxes usually go up for the new owner, sometimes steeply; not something you want to stick to your kids or partner.

Fortunately, state law also offers a few valuable exceptions so you can manage your real estate with minimal property tax impact. It’s understandable that when you’re planning estate transfers or your own retirement, property taxes aren’t top of mind. But, before you sell that property or transfer part of the ownership to a family member, trust or co-owner, be aware of what you can do… and how to do it right.

The limits and leniencies of the law

Proposition 13, passed by California voters in 1978, was a groundbreaking law that helped to keep property taxes under control for homeowners. However, it can also cause some headaches and heartbreaks when you want to transfer that house you’ve owned for 20 years to loved ones, or put property into an entity for liability protection or investment purposes, and are faced with a whopping tax hike.

Prop. 13 sets a property’s base-year value to what it was in 1975 or when it last changed ownership. Then it allows for annual property tax increases of no more than 2% until it changes hands again. In most cases, the portion that’s transferred is reappraised to the full current market value. This could result in a substantial property tax increase if the property has appreciated since the time of the previous transfer.

However, California also allows for several exclusions to the change-in-ownership rule that benefit couples (married or not), families and co-owners. Some of these exclusions are automatic, but others require filing a special form. Below are the highlights of some common scenarios and exclusions that may help you avoid unwanted property tax increases.

Automatic exclusions

Transfers between spouses and registered domestic partners (DP) — Reassessment is automatically avoided when the property is transferred to a spouse or DP:

  • Through a trust (there are certain requirements to qualify)
  • When one is being added to the title
  • When one dies
  • Upon divorce or termination of the partnership

For example, if you bought a home when you were single and later get married, you can add your spouse to the title without facing a property tax increase. Then, when one of you dies, that half can transfer to the survivor without reassessment.

Transfers solely to change the method of holding title — This can be done between an individual and a legal entity, or between entities. Proportional ownership interests, however, must remain the same.

One scenario would be if a married couple jointly owns a commercial property 50/50 but wants to transfer it to a limited liability company (LLC) for liability protection. No reassessment will occur if the husband and wife are each 50% owners of the LLC.

You can also qualify for an automatic exclusion from reassessment when:

  • Correcting the name of a person holding title (e.g., a name change upon marriage)
  • Changing title related to lender’s security interest or for financing purposes only
  • Changing the trustee of the trust holding the property
  • Transferring the property into or out of a revocable living trust

Exclusions that require paperwork

After Prop. 13 was passed, other laws were approved that allowed for exclusions to certain common property transfers, making life just a bit easier. For these common property transfers, you’re required to file a specific claim for reassessment exclusion.

Transfer from parent to child or child to parent — Proposition 58 passed in 1986 allows for certain transfers between parents and children without reassessment. This includes transfer by a parent into a trust for the benefit of a child. It applies only to a principal residence and up to $1 million of other property per transferor. A common technique is for a parent to create an irrevocable trust for the benefit of a child and then transfer the home to the trust either to reduce the parents’ taxable estate or allow an adult child to use the home rent-free. For this exclusion, you need Form 58-AH.

Transfer from grandparent to grandchild — Ten years later, voters adopted Proposition 193 to allow a grandparent to transfer property to a grandchild without reassessment if the grandchild’s parent died on or before the date of transfer. This requires Form 58-G.

Transfer among original joint tenants — If two individuals jointly own property, and one dies, the deceased individual’s half gets transferred to the surviving owner. To avoid reassessment, the two cotenants must have owned 100% of the property for one year prior to the death of one cotenant, the property must have been the principal residence for both for one year prior to death, and the survivor must keep 100%. The surviving tenant will need to sign an Affidavit of Cotenant Residency.

One-time purchase of replacement dwelling by a person 55 years or older — Older clients who want to downsize can buy a new home (of equal or lesser value) while retaining the property tax basis of the home being sold. Proposition 60 allows this when buying within the same county. Proposition 90 expanded the transfer to counties that choose to allow it. Currently, 11 counties permit Prop. 90 base-value transfers, including Los Angeles, San Diego and Santa Clara. Use Form 60-AH.

Legal entity exclusion — A transfer of an interest in a legal entity does not trigger reassessment of real property except in certain situations. While there are many intricacies to the rules of this exclusion, generally reassessment occurs if upon transfer 1) a person or legal entity acquires more than 50% ownership in the entity, or 2) cumulatively, more than 50% of the original owners’ interests are transferred.

For example, if investment real estate is owned by a partnership held in the name of two brothers, and 30% of the partnership is transferred to a sister, the property tax basis would not change. If, however, the sister receives a 51% interest in the partnership, the property would be reassessed, possibly increasing the property tax liability.

Therefore, this potential tax hike should be considered when transferring ownership interests. Either way, Form BOE-100-B needs to be filed within 90 days of transfer.

Using reassessment to your advantage

Keep in mind that Prop. 13 reassessment could also work in your favor if the property value drops. While you would rather see the value of your home increase, at least you may find a silver lining in a down market. It’s rare, but it happened to many owners less than 10 years ago. If you happen to be in that situation and have a taxable estate, you may consider transferring the property out of your estate. This will not only reset the property tax basis to a lower value, but also potentially reduce your estate tax value.

Owning real estate is the classic American dream, and being able to pass along that investment is a source of pride for many of us. But navigating complex property tax laws cannot be overlooked in the process. No matter where your property is located, getting sound estate planning advice can help you and your family enjoy that dream for generations to come.