Estate Planning: Avoiding Reassessment When Transferring Real Property to an Entity

California taxpayers made their voices heard in 1978 when they went to the polls and approved Proposition 13. Under Proposition 13, property taxes are limited to one percent of the assessed value. Additional property taxes may be approved for schools or local projects, which can vary amongst communities and bring the tax rate higher than one percent.  It also capped subsequent property tax increases at two percent a year while rolling back the assessed values of property for homeowners to 1975 levels. Prop.13 protects property owners against uncontrolled jumps in the assessed valuation due to the dramatic surge in the market value of California real estate by limiting annual increases in assessed values to a maximum of two percent. Only an ownership change or new construction can trigger a reassessment to current fair market values; however, careful estate planning can help a property owner preserve their current assessment when transferring ownership to an entity, such as a limited liability company or partnership.

Sale or Transfer of Real Property: Avoiding Reassessment

The value of protecting a primary residence or investment property from reassessment under Prop.13 can best be illustrated by looking at median home values in 1975. The home you purchased back then for roughly $50,000 could be worth as much as $548,000 today. Unless you transferred ownership or did new construction on the house, your assessed value would only have increased by up to two percent each year depending upon inflation allowing you to avoid paying significantly higher real property taxes.

Transfers between spouses or from a parent to a child do not trigger a reassessment, but care must be taken when ownership is transferred to an entity, such as a trust, a limited liability company or a partnership. Legal advice should be sought from a knowledgeable estate planning attorney to ensure that any such transfer does not result in the loss of the protection from a reassessment of the property afforded by Prop.13.

Transfers of Ownership to Legal Entities

Many people transfer their investment real estate to legal entities to protect them from creditors. Another common reason is in connection with estate tax planning so that interests in the entity can be gifted. If there is more than one owner, an entity is almost always going to be preferred to tenancy in common ownership.   If you own real property subject to Prop.13, a transfer of ownership to a legal entity, such as a limited liability company or partnership, is excluded from a reassessment as long as the transfer changes how the title is held without changing proportional ownership. For example, if you transfer real property you own to a limited liability company of which you are the only member, the transfer would be excluded from reassessment because you owned 100 percent of the property and now own 100 percent of the limited liability company.

The initial transfer to a legal entity will not trigger a reassessment, but subsequent transfers of the interests in the limited liability company or other legal entity can result in a reassessment. This occurs when more than 50% of the interests have been transferred in one or more transactions or if one of the entity owners goes over 50% ownership having previously held less than 50%. Another complication is that the Proposition 58 exclusion protecting real property transfers between parents and their children would not apply to a change in ownership of interests in an entity. As a result, when and whether to transfer real property into an entity and when and whether to transfer interests in an entity that owns real property must be planned very carefully.

Transfer of Ownership to Trust

Transferring real property to a revocable trust does not cause a loss of the Prop.13 protection against reassessment as long as the person transferring the property has the power to revoke the trust or in situations in which the creation of the trust was for the benefit of the person transferring the property or for the person’s spouse. This type of transfer is not treated as a change of ownership that would result in a reassessment. The same rule applies to irrevocable trusts provided they are established for the benefit of the creator of the trust or the creator’s husband or wife.

Upon the death of the creator of a revocable trust, the trust is treated the same as an irrevocable trust for purposes of Prop.13. The death results in a change of ownership that triggers a reassessment. However, trust property left to a child of the now-deceased creator of the trust could be subject to exclusion from reassessment under Prop. 58.

Consult an Estate Planning Attorney

The benefits of Propositions 13 and 58 can be lost without legal advice and representation from an experienced estate planning attorney. Learn more about how to protect real property from reassessment by calling the estate planning attorneys at Magee & Adler at 562-432-1001 to schedule an appointment.