How to Avoid California Property Tax Reassessment
California property tax planning, and more specifically, avoiding reassessment of property taxes has never been more important. We assist clients with proper planning to minimize or avoid future property tax reassessment.
With the passing of California’s Proposition 19, the ability to transfer your home or other real property to your children without property tax reassessment has been significantly reduced. Prop 19 applies to all transfers of real property on or after February 16, 2021. If you are already familiar with Proposition 13 and 19 you can skip to Property Tax Planning under Proposition 19 below.
We have assisted many California real property owners with avoiding property tax reassessment. For a detailed analysis of your specific situation, please call us at (949) 371-5003.
Background of California Property Taxes
Since the passing of Proposition 13 in 1978, the assessed value of real property increases by no more than 2% annually. Since the fair market value of California real property has far exceeded the 2% annual adjustment, owners of California real property enjoy a lower property tax burden compared to owners of newly acquired property. This has not changed under Proposition 19. However, when you transfer (gift, transfer on death, or sell) real property, the property is reassessed at the current fair market value. Under prior law, California provided two important exemptions from reassessment when transferring real property between parents and children.
Exemption No. 1: A transfer of a parent’s principal residence to a child is completely exempted from reassessment. The child succeeds to the parent’s assessed value regardless of the value of the property or its assessed value at the time of transfer. It also does not matter whether the child decides to use the home as his or her primary residence, a vacation home or as a rental.
Exemption No. 2: Transfers of other real property interests (residential or commercial) of up to $1 million of total taxable value are exempted from reassessment, regardless of the fair market value of the property at the time of transfer. This $1 million exemption is per transferor/spouse.
New California Property Tax Law Under Proposition 19
Proposition 19 completely eliminates Exemption No. 2. Parents will no longer be able to transfer real property that is not their primary residence to their children without reassessment. If you have a vacation home or rental property, they will be reassessed at the time of transfer to your children. There are different rules for LLCs, which are discussed below.
Proposition 19 also limits the use of Exemption No. 1. First, only a transfer of the parent’s principal residence to the child where the property continues as the child’s principal residence qualifies. Second, provided the transfer meets the principal residence requirements, the child’s taxable value is then determined based upon whether the property’s assessed value (fair market value) at the time of transfer is greater than the parent’s taxable value by more than $1 million. If the assessed value of the property at the time of the transfer exceeds the parent’s taxable value by less than $1 million, then the child assumes the parent’s current taxable value. If the assessed value of the property at the time of the transfer exceeds the parent’s taxable value by more than $1 million, then the child’s taxable value is the current assessed value of the property less $1 million. This exemption only lasts for as long as it is the child’s primary residence.
Property Tax Reassessment Problem
Example: You purchased a commercial building in 1988 for $500,000. The current taxable value of the commercial property is $1,000,000. Based upon the taxable value, the annual property taxes are approximately $12,500 per year. It is currently worth approximately $4,000,000. If you passed away this year, the new property taxes would be approximately $50,000 per year, which means an increase of $37,500 in property taxes each year! This is a horrible result that may require your children or other beneficiaries to sell the property. Holding property in your trust does not change the outcome for property tax purposes.
How do we plan around this? Consider the use of Prop 19 LLCs as discussed below.
California Property Tax Planning under Proposition 19
There is a completely different set of rules that apply to property tax reassessment for real estate owned by business entities (typically LLCs) and this is where we still have an opportunity to avoid future property tax reassessment. The easiest way to accomplish this is by acquiring the property in the LLC in the first place (not in your individual names and then transferring it to an LLC later). If the LLC is the original owner, then as long as no new person gains more than 50% ownership/control of the LLC, then there will be no reassessment of the underlying property. This law was tested in Ocean Avenue LLC vs. County of Los Angeles wherein Michael Dell and his family purchased Ocean Avenue, LLP, which in turn owned the Fairmont Miramar Hotel in Los Angeles. However, when the Dell family purchased Ocean Avenue LLC, no one person had more than a 50% interest in the LLC. Long story short, the Court upheld the law and confirmed there would be no reassessment. If you have acquired property in the name of an LLC, you need to make sure your planning is structured in a way that no person gains more than a 50% interest in your LLC. This can be easily accomplished when you have two children that are beneficiaries of the LLC.
However, for the rest of us that have acquired property in our individual names and then later transfer it to an LLC (because of financing issues, etc.), we live by a different set of rules. If the original owners of the LLC (the individuals that transfer the property to the LLC) transfer more than 50% of the LLC cumulatively to anyone else, the entire property will be reassessed. Example: You transfer your commercial property from you, as an individual, to your LLC, which you own 100%. You later transfer 50% of the LLC to your children. This does not cause a reassessment since you have not transferred more than 50%. However, the following year, you transfer an additional 1% to your sister. The entire property will be reassessed upon the 1% transfer to your sister because you cumulatively transferred 51%. You should note, if the property was originally purchased by the LLC, then the 1% transfer to your sister would not have triggered a reassessment because no new person gains more than a 50% ownership/control. However, in this example, since the LLC was not the original owner, the property is reassessed upon the 1% transfer. Because of these rules, if you don’t make any transfers during your lifetime and you own the LLC until your death, then the underlying property will be reassessed at the fair market value upon your death.
Using Special LLCs to Avoid Property Tax Reassessment
Each situation is different, however, in general, we use a series of LLCs to systematically transfer the property to your children (or other beneficiaries) over a period of time. Each transaction avoids these detailed reassessment rules. The passing of proposition 19 has not changed this opportunity. However, there is always a concern that the assessor may attempt to collapse all of these steps into one (referred to as the “step doctrine”) and reassess the property later. The ultimate solution will depend on the number of properties, number of beneficiaries, the value of your estate, and your need to keep the rental income for yourself.
Modern Wealth Law helps clients throughout California with property tax planning for over 15 years, Attorney John Wong is a California Certified Specialist in estate planning & probate law and can assist you with how to best avoid property tax reassessment in the future. If you have questions regarding California property tax reassessment, call Modern Wealth Law at (949) 371-5003 to schedule a consultation regarding your matter.
