Avoid Unexpected Property Tax Reassessments for Your Children
If you own property and want to transfer it to a family member or leave it to your children when you die, you need to carefully consider how California’s property tax rules apply to your plans. We recently helped our client “Mason” who, along with his siblings, inherited a house from his mother to avoid a property tax reassessment. After almost one year of coordination between Mason, his attorney, and the county clerk’s office, we are still waiting to hear the final verdict on whether our client can avoid the reassessment by applying the full amount of parent child exclusion. With proper planning, a similar situation may be avoided.
California Property Tax
California real estate is generally taxed at 1% of the property’s “assessed value”; the assessed value is the fair market value as of the date of a change in ownership. The law limits increases to the assessed value to no more than 2% each year. When there is a change in ownership, the property value is generally reassessed and the new owner pays property tax based on the new value.
Property Transfer between Parent & Child
Generally speaking, a transfer of property from parent to child is not subject to reassessment, so the child will pay the same lower rate the parent paid. However, there are significant limitations and pitfalls to be aware of:
- If you transfer your property into a revocable living trust, there is no “change of ownership” and thus no reassessment. However, it is important to have your revocable trust contain planning to qualify your property for the parent-child exclusion to avoid a change of ownership and reassessment upon death. In Mason’s example, he inherited the house along with his siblings but only Mason wants to live in the house. The trust merely provides the property to all children equally (each getting a one half interest). This resulted in Mason’s siblings having to transfer or sell their interests to Mason in exchange for an equalizing payment. Since this would no longer be a parent-child transfer, but a sibling-to-sibling transfer, it may trigger a partial property tax reassessment (except for Mason’s share).
- Each parent can transfer to the child, so one child can theoretically only receive two principal dwellings and up to $2,000,000 in full cash value of other types of property without triggering reassessment. This is assuming the parents were married and properties were being held for the surviving spouse.
- The parent-child exclusion also applies to step-children and adopted children. The spouse of a child (son or daughter in-law) is eligible unless the relationship ends in divorce. Grandparents may also take advantage of this exclusion under specific circumstances.
- Some people transfer their property to an entity such as limited liability company to help protect their other assets from lawsuits. One downside of doing so is that the property may be reassessed when the interest in the limited liability company is given to the children by gift or inheritance. The reason is that the parent-child exclusion only applies to transfers of real property, not to interests in an entity.
- Allow for “non-pro rata” distributions in your revocable living trust- so unequal distribution of the trust assets can be made. Non-pro rata trust language can allow one child to get the house without triggering reassessment and others get other trust assets of equal value.
- Avoid transferring property to entities unless you consult with your attorney.
- If a beneficiary receives a present beneficial use or income from a property, then it is deemed that there has been a change in ownership. Generally, the beneficiary generally should not live on the property or collect rental income.
- All beneficiaries must qualify for the exclusion to avoid reassessment. The entire property will be reassessed if even one beneficiary does not qualify! For example: The decedent leaves 80% of her estate (including the house) to her only child and the remaining 20% to a non-child charity. The parties agree to leave the house to the child while the charity gets the balance of the estate. In this case, the assessor may challenge the transfer and refuse to allow the exemption to 20% of the property, claiming that the 20% was effectively transferred from the charity to the child.