A common estate-planning question is how to transfer property under Prop 13 either now or after death to a family member without a reassessment of property taxes. Given current real property values in California, a reassessment of the property could cost the family member inheriting the property potentially thousands of dollars in additional property taxes each year. So, what is the law and how can you avoid an unnecessary reassessment under Prop 13?
The general rule is that unless an exclusion applies, the value of real property is reappraised for property tax purposes whenever there is a change in ownership. So what are the exceptions under Prop 13?
1. Property transferred between spouses or registered domestic partners
2. Parent transfers to children OR children transfers to parent OR grandparent transfers to grandchildren whose deceased parent was the child of the grandparents
*Important Note: A transfer of real property from a partnership, LLC or corporation to a child does not qualify under this exclusion and the property will be reassessed.
Next important question: What kinds of property can be transferred under Prop 13?
A principal residence; and
Up to $1 million(assessed value, up to $1 million (assessed value, not fair market value)
A commonly overlooked issue is distribution of property that is being held in a trust. Here is an example: Grantor (person who created the trust i.e. generally the parent) has 3 children and the title to the Grantor’s home is held by the trust. Additionally, the trust provides that upon the Grantor’s death, all assets in the trust are to be divided equally to the 3 children. This is a very common provision in many trusts. However, unless, careful planning is untaken, if one child wants to take the property, the property will be reassessed for 2/3 of its value (the property will be reassessed by 2/3 to account for the “sale” by the other 2 children).
This problem can be avoided if the Trust has been carefully crafted. The first way to avoid the reassessment is allow 1) the Trustee to encumber the property before a distribution and 2) for a non pro-rata distribution of assets. Secondly, the reassessment can be avoided if the Trust provides for a specific distribution of the property to the intended child.
Another common provision is for the children have the “right” to purchase the property interest from their other siblings (ie one child can “buy-out” his or her siblings). Unfortunately, this provision will not avoid the reassessment. To ensure that the Trustee can distribute the property to the intended child and protect against reassessment, the Trust documents must contain sufficient trustee powers to allow the Trustee to engage in the necessary transactions prior to the transfer of the property.