Using Exclusions To Avoid Reassessment

How to Structure Transactions That Won’t Increase Property Taxes

This article explains what triggers reassessment of real property and gives practical tips on what to do and not do when relying on exclusions to avoid property tax increases. While this article is not intended as a complete guide regarding property tax laws, it is intended to highlight the most common exclusions used when structuring real property transactions. Information in this article has been derived in part from written and oral opinions from the State Board of Equalization (the “SBOE”). Since county assessors are not bound by the SBOE’s opinions, use caution when relying on information contained in this article.

Quick background: Under Proposition 13, the assessed value of real property for calculating property taxes was rolled back to March 1, 1975 values (“Base Year Value”), increased annually by an inflation factor, not to exceed 2 percent annually. Completion of new construction or a change in ownership (“CIO”) triggers a reassessment to a new Base Year Value equal to the current fair market value, meaning higher property taxes. A CIO is a transfer of a present beneficial interest in real property when the interest being transferred is equal to the value of the fee interest. The key to avoiding property tax increases is to either avoid a CIO or qualify for an “exclusion” under the Revenue and Taxation Code (the “Code”). This article focuses on using the most common exclusions in the Code to avoid property tax increases.

Using The Legal Entity Exclusion To Avoid Reassessment

Section 64(a)(c) and (d)

• A transfer of an interest in a legal entity is not a CIO of the real property owned by the entity except as provided in sections 64(c) and (d). In other words, if Corporation AB owns real property and 50% of the shareholders transfer their interest to Corporation X and 50% of the shareholders transfer their interest to Corporation Y, there is no CIO or reassessment of the real property (assuming no one individual or entity obtains control of AB Corporation as a result of the transfer).
• ACTION TO CONSIDER: When transferring an interest in an entity that owns real property, always trace the prior ownership of real property. A transfer of more than 50% of the interests of “original co-owners” in a legal entity is a CIO of the real property owned by the entity. For example, assume A and B, 50/50 owners of AB Corporation, transferred real property to Corporation AB. A and B cannot then transfer all of their Original Co-Owner interest to Corporation X and Corporation Y, without the property being reassessed.
• ACTION TO CONSIDER: Before transferring more than 50% of the voting stock of any entity, determine if the entity owns real property that might be reassessed. A transfer of more than a 50% of an interest in a legal entity could trigger a CIO and property owned by that entity will be reassessed. For example, if A is an “original co-owner”, A representing 51% of the voting stock cannot transfer her interest in Corporation AB to Corporation X, without the property being reassessed.

Using The Proportional Interest Exclusion To Avoid Reassessment 

Section 62(a)2

• Whereas the Legal Entity Exclusion prevents reassessment in transfers between legal entities, the Proportionate Interest Transfer Exclusion is the ONLY exclusion that can avoid reassessment for transfers to or from an individual to a legal entity. So long as the individuals and the legal entity have the same proportional ownership interests, the real property will not be reassessed when transferred to or from the entity or the individual. A and B can transfer property owned by them 50/50 to an LLC owned by them 50/50 without reassessment. Mom, Dad and Son owning real property 40%, 40% and 20% can also transfer the real property to an LLC in which the Mom, Dad and Son have the same proportionate interests.
• ACTION TO CONSIDER: To avoid property tax reassessment, do not transfer real property from individuals to a legal entity unless the individuals have the same proportionate interest in the legal entity as they did in the real property. No exclusion will apply if Mom and Dad as 100% owners transfer real property to an LLC owned 45% Mom, 45% Dad and 10% Son. Instead, Mom and Dad should first transfer a 10% interest in the real property to Son (qualifies for Parent-Child Exclusion), and then transfer the property to the LLC owned 45% Mom, 45% Dad and 10% Son. Caution: The step transaction doctrine may apply and the property could be reassessed if the Parent-Child Exclusion did not apply in the above example.

Using The Original Transferor Rule To Delay Reassessment 

Section 65 and amended Rule 462.040

• The Original Transferor rule will delay reassessment when one joint tenant dies and is survived by a joint tenant who is an Original Transferor. The exclusion applies when a joint tenant transfers real property to a living trust in which the other joint tenant is a beneficiary. For example, if A and B Joint Tenants form a revocable trust with each other as beneficiaries, A and B both become Original Transferors. When the property passes to the other upon the death of A or B, the real property is not reassessed. The exclusion also applies when only one joint tenant forms a revocable trust and the other (former) joint tenant dies. For example, if Joint Tenant B transfers his share of real property into a trust for the benefit of A, then B becomes Original Transferor: If A dies and property passes to B, the property avoids reassessment since B is Original Transferor.
• ACTION TO CONSIDER: In a purchase-sale transaction or in a trust distribution, transfer title to co-owners as tenants in common (“TIC”), and then transfer the property from TIC to Joint Tenants. Then, the co-owners become Original Transferors: If one of them dies, the property will not be reassessed. If the co-owners had originally taken title as joint tenants and one of them dies, the real property will be reassessed (unless another exclusion applies like Parent-Child or Spouse-to-Spouse). Consider having joint tenants transfer property out of joint tenancy (from joint tenants to tenants in common) and then back into joint tenancy (from tenants in common to joint tenants) and then into the trust for each other’s benefit so that the transaction qualifies under the traditional Original Transferor exclusion rule (because the transfer back into joint tenants made each of them “original transferors”) as well as under amended Rule 464.040. However, depending on the facts and circumstances surrounding each of these transfers, an assessor may apply the step transaction doctrine, resulting in a CIO.

Using The Domestic Partner Exclusions To Avoid Reassessment

Property Tax Rule 462.240(k) and Section 62(p)

• For all deaths and transfers that occur on or after July 1, 2003, Rule 462.24(k) applies so that property left to a Registered Domestic Partner by intestate succession will not be reassessed. Note that the SBOE has indicated that this rule should apply to all on-death transfers (those by will or trust), assessors might limit the exclusion to intestate transfers only.” For example, Partner 1 dies without a will or trust, and the property passes to Partner 2 by intestate succession. The property will not be reassessed upon transfer to Partner 2.
• New Section 62(p) of the Rev. & Tax. Code, excludes from reassessment most transfers between Registered Domestic Partners, whether during life or on death, if the transfers occur on or after January 1, 2006. For example, Partner 1 creates a trust naming Partner 2 as beneficiary. Partner 1 dies. The property will not be reassessed upon transfer to Partner 2. Partner 1 can also transfer title during life to Partner 2 without triggering reassessment.
• ACTION TO CONSIDER: Do not transfer real property from Partner 1 to Partner 2 without addressing the gift tax consequences with a tax attorney. Even though under section 62(p), the property should avoid reassessment for property tax purposes, it is unclear whether Partner 2’s community property interest in the property under the Domestic Partnership laws will be recognized to avoid the transfer being classified as a gift.

Using The Parent-Child Exclusion To Avoid Reassessment After Proposition 19

Section 63.1 as modified by Assembly Constitutional Amendment No. 11, Section 2.1

• Proposition 19 was passed by California voters on November 3, 2020, and went into effect on February 16, 2021 as Assembly Constitutional Amendment No. 11, changing the Parent-Child Exclusion from the rules under Section 63.1.
• For transfers after February 16, 2021, the Parent-Child Exclusion allows parents to transfer a principal residence or a family farm to their children without full reassessment, if the child makes the home their principal residence after the transfer or continues to use the property as a farm. If a home is being transferred, the child must claim the homeowner’s exemption to show that the child is using the property as the child’s principal residence (Claim for Reassessment Exclusion Form BOE-58-AH, and Claim for Homeowners’ Property Tax Exemption Form BOE-266 required). Importantly, the exclusion is limited to the property’s existing assessed value, plus $1,000,000 (as annually adjusted). Even if all requirements above are met, the property will be reassessed to the extent the fair market value exceeds the existing assessed value plus $1,000,000.
• ACTION TO CONSIDER: Since the exclusion does not apply to transfers to legal entities, always transfer real property to a Child before transferring the property to an entity. See example above under Proportional Interest Exclusion.
• ACTION TO CONSIDER: The exclusion does not apply to grandchildren unless both parents are deceased. Therefore, consider not having living grandchildren as trust beneficiaries unless both parents are deceased. Otherwise, each time a new grandchild is born, the property will be reassessed. Instead of allowing a trustee to sprinkle income to “issue”, either only include Spouse and Child as trust beneficiaries, or use a trust protector or special trustee to sprinkle income to grandchildren, but only under circumstances that would not result in a reassessment of real property held in the trust.
• ACTION TO CONSIDER: Whereas the Parent-Child Exclusion applies to non pro rata trust distributions from Mom to Son and Daughter, it does not apply to transfers between Son and Daughter. Therefore, it is preferable to give the trustee discretion in distributing assets to Son and Daughter and allow non pro rata distributions rather than to require trustee to give Son or Daughter a specific property. Otherwise, if Son and Daughter want to swap properties after trust distribution, the properties will be reassessed.
• ACTION TO CONSIDER: There are various strategies available to combine the parent-child exclusion from reassessment with the de minimus exception and entity exclusion rules to minimize reassessment of property taxes.

Using The Cotenancy Exclusion At Death

Section 62.3 

• The Cotenancy Exclusion from Reassessment allows a transfer from one cotenant to another that takes effect on the death of one transferor cotenant to be excluded from property tax reassessment.
• ACTION TO CONSIDER: The following conditions must be satisfied to claim this exclusion from reassessment after the death of a cotenant: (1) the two cotenants must own 100% of the property together; (2) the two cotenants must be owners of record for the one-year period preceding the death of one of the cotenants; (3) the property must have been the principal residence of both cotenants for the one-year period immediately preceding the death of one of the cotenants; and (4) the surviving co-tenant must obtain 100% of the ownership interest in the property. The cotenants must own the property as joint tenants or tenants-in-common, however, the deceased cotenant’s interest in the property may be transferred to the surviving cotenant at death by a trust, will, or court order.
• ACTION TO CONSIDER: The surviving cotenant that receives the property must file an affidavit with the county recorder, in which the surviving cotenant affirms under penalty of perjury that the cotenants used the property as the cotenants’ principal place of residence for the one-year period preceding the cotenant’s death. Additional proof of residency may be required if the Homeowners’ Property Tax Exemption was not granted to both cotenants prior to the death of a cotenant.

Property tax planning is a complex area of the law. Without a complete understanding of the issues, one could easily trigger a reassessment of property that could have been avoided with proper planning.

Attorney Michelle C. Lerman, a board member of the Marin County Bar Association, practices in estate planning, probate, trust administration and co-ownership issues. She and her husband, Jeffrey H. Lerman, are partners of Lerman Law Partners, LLP, which has offices in Los Angeles and San Rafael. In addition to estate planning, the firm has expertise in business, real estate transactions, litigation, and finance. www.lermanlaw.com