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

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

California law previously provided generous exceptions for transferring real property to children while retaining the lower property tax basis. Proposition 19, passed in 2020, significantly limited the parent-child exclusion. However, the voter initiative did expand the ability of older adults to move and transfer their property tax basis to a new home in California.

When planning estate transfers or your own retirement, it’s understandable that 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 lead to some headaches and heartbreaks when you want to transfer that house you’ve owned for decades 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 tax increase if the property has appreciated since the time of the previous transfer.

However, even after the dramatic changes made by Prop. 19, California allows for 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 that you don’t want to overlook. 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 spouse’s 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 two individuals jointly own a commercial property 50/50 but want to transfer it to a limited liability company (LLC) for liability protection. No reassessment will occur if each individual is a 50% owner 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 passed, other laws were approved that allowed for exclusions to certain common property transfers, making life a bit easier. For these types of property transfers, you’re required to file a specific claim for reassessment exclusion.

Buying a replacement home — Prop. 19 expanded previous rules allowing older homeowners to transfer their tax assessments to a replacement dwelling. Effective April 1, 2021, homeowners age 55 and older can move anywhere within California (rather than only to certain counties) and transfer their original Prop. 13 tax assessment to a home of equal or lesser value, or to a more expensive home, with an upward adjustment. You can do so up to three times during your lifetime, whereas before, you could do so only once. For transfers occurring before April 1, 2021, use your county-specific version of Form 60-AH.

In addition, Prop. 19 makes this exception available to people with severe disabilities or who are victims of natural disasters, such as the firestorms and floods many Californians have faced.

Transfers to children — On the other hand, Prop. 19 also eliminated most of the exemptions to transfer property to children. Effective February 16, 2021, all property transfers to children will be reassessed, with one limited exception for the transfer of a primary residence to a child, as long as the child uses the home as their primary residence. However, if the home is worth more than $1 million, an upward tax adjustment will occur. Previously, a parent had an unlimited ability to transfer a primary residence to their children, as well as other property of up to $1 million of assessed value, including commercial property. Use either Claim for Reassessment Exclusion for Transfer Between Parent and Child or Between Grandparent and Grandchild (a more limited exception).

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, 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.

Legal entity exclusion — Transferring 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 a person or legal entity acquires more than 50% ownership in the entity or when more than 50% of the original owners’ interests are (cumulatively) 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, if 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 carefully considered when transferring ownership interests. Either way, a separate form 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. You can always argue that your property tax should be decreased if your property value drops, but then future increases would not be limited to the 2% annual increase. However, if you transfer the property and trigger reassessment, you can reset the property tax basis and future increases to the lower value. 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.

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.

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Editor’s note: This article has been updated since its original October 12, 2016, publication.