May 22, 2019
Property Taxes: The Often-Overlooked Transfer Tax
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Thursday, December 3rd | 10:30 - 11:30am
Hosted by David Newson, Judith Gordon, and Michelle Soto
May 22, 2019
Please read important disclosures HERE.
For many people, worrying about a 40% gift or estate tax on transfers of assets to heirs may be a thing of the past. 2019 federal gift and estate tax exemptions are currently at an all-time high — approximately $11.2 million per individual and $22.4 million for a married couple. In California, there is no separate inheritance tax.
In addition to these estate and gift tax exemptions, people may use a variety of other strategies to reduce the tax burden associated with gifts and inheritances. For instance, astute individuals may structure their estate plans to make certain (to the extent possible), their assets receive a step-up in basis for income tax purposes when both the first and second spouse die. Many people have also established and funded revocable living trusts with primary residences, rental properties, and vacation homes so that these assets may be transferred to heirs without the hassle and costs of probate administration.
So, while many individuals may think they have covered their bases to minimize taxes and costs for their heirs when they die, some may not realize that significant increases in property taxes can be imposed when real property is gifted either during lifetime or at death. With property values in the San Francisco Bay Area some of the highest in the country, each owner of real estate should be aware of the property tax rules and, in particular, valuable opportunities to minimize increases in property taxes when there is a change in ownership.
Proposition 13 and Other Property Tax Exclusion Provisions
In 1978, California voters overwhelmingly approved Proposition 13, a property tax limitation initiative. Under Prop 13, most property tax values were rolled back and frozen at their 1975 assessed values. Property tax increases were limited to no more than 2% per year as long as a “change in ownership” did not occur. A change in ownership causes the property tax to be reassessed at 1% of the current market value and the 2% yearly cap becomes applicable to subsequent years.
While many Californians may know about Proposition 13, homeowners should also be aware that other California property laws allow for certain exclusions to the change in ownership rules, which in certain circumstances may help homeowners avoid unwanted property tax increases.
A few of these more common property tax exclusions include:
Another popular exclusion from property tax reassessment involves transfers from parent to child or child to parent and in certain instances, transfers from grandparent to grandchild. In 1986, California voters passed Proposition 58, which allowed for certain transfers after November 6, 1986, between parents and children without triggering a tax reassessment. Each parent can transfer during their lifetime or at death, their primary residence (no value limit) and up to the first $1 million dollars of assessed value of other properties (per transferor) without the property being reassessed.
Additionally, under Proposition 193 passed in 1996, a grandparent can also transfer property to a grandchild provided that all the parents of the grandchildren who qualify as children of the grandparents are deceased as of the date of transfer.
Property Tax: Wise Planning Opportunities
The following are a few hypothetical examples of situations that present opportunities to minimize California property tax reassessments using the applicable exclusions.
When Maureen’s mother Carol passed away, she left the family home in equal shares to Maureen and her brother Bob. Maureen wanted to own the home by herself and could afford to purchase Bob’s half of the home for cash. Even with Proposition 58, Maureen’s purchase of Bob’s 50% interest in Carol’s home using her own money would have been deemed a change in ownership and would have triggered a property tax reassessment on a 50% interest of the home.
Maureen would benefit to know that the California State Board of Equalization approved a workaround of the reassessment of the 50% interest. Instead of using Maureen’s own money to buy out Bob’s interest, the trustee of Carol’s trust could borrow money from a third-party lender, secure the loan with the home, and then distribute the entire home to Maureen (encumbered by the loan amount). The trustee would then give cash of an equal amount to Bob so that the trust assets were distributed equally and without any property tax reassessment. This technique is often referred to as “Share-and-Share-Alike Distribution.”
In another case, Bruce died and left 60% of a rental property to his son Jeff and 40% to his daughter Michelle. Since the assessed value of the rental property was under $1 million dollars, under Proposition 58, there was no reassessment of the property when Bruce died. Jeff then transferred his 60% interest to himself and his wife Sara and avoided reassessment under the spousal transfer exclusion. Two years later, Jeff wanted to buy his sister Michelle’s share of the rental property but did not want to trigger a property tax reassessment.
Under the proportional transfers of real property rule, Jeff, Sara, and Michelle formed a partnership and contributed their respective ownership interests to the partnership for their same proportional partnership interests (60/40) without triggering a reassessment. Sometime later, Jeff and Sara purchased Michelle’s 40% partnership interest and since less than 50% of the original co-owners’ interests were transferred, there was no reassessment of the property.
Be Proactive and Seek Advice
A word of caution: these types of techniques must be handled very carefully with expert advice on how to proceed and proper documentation and substantiation filed with the county assessor. However, if done correctly, lower tax bases may be maintained and over time, potentially tens of thousands of dollars could be saved. For those owning property in states other than California, the laws of the state in which the property is located will dictate the methods and circumstances by which property taxes are assessed and reassessed and should be reviewed and understood.
If you are considering an acquisition or transfer of property, it is wise to be proactive and seek good advice ahead of time. If you would like to learn more about property tax reassessments and applicable exclusions, please contact your tax professional or your B|O|S advisor.
It is the responsibility of any person or persons in possession of this material to inform himself or herself of and to seek appropriate advice regarding any investment or financial planning decisions, legal requirements, and taxation regulations which might be relevant to this topic and to his or her specific situation.
Opinions expressed in this article, which are not reliable as fact, are current as of 5/22/19 and are subject to change.
This article provides a general overview of a particular estate planning topic and is not intended to be an exhaustive summary of every practical element of that topic. Many important elements of each subject are not discussed herein. This article is for informational purposes only and is not intended to be used as a general guide to estate planning or as a source of any specific recommendations, and makes no implied or express recommendations concerning the manner in which any individual’s account should or would be handled, as appropriate estate planning strategies depend upon the individual’s specific objectives and circumstances. It is the responsibility of any person or persons in possession of this material to inform himself or herself of and to seek appropriate advice regarding any investment, financial planning, or estate planning decisions, legal requirements, and taxation regulations which might be relevant to the topic of this article or the subscription, purchase, holding, exchange, redemption or disposal of any investments.
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Opinions expressed are current opinions as of May 2019 and are subject to change. No part of this material may, without the prior written consent of Bingham, Osborn & Scarborough, LLC, be (i) copied, photocopied or duplicated in any form, by any means, or (ii) distributed to any person that is not an employee, officer, director, or authorized agent of the recipient.