Real Property Taxes - Change in Ownership

Under Proposition 13, real property owners in California pay real property taxes based on the “acquisition value”, which refers to the fair market value at the time of acquisition. This acquisition value is established as the base year value for the property. From that point on the real property taxes for the property are locked in at that value except for increases based on annual increases in the California consumer price index (CPI) but the increases are capped at a maximum of 2% per year.

Since the establishment of Proposition 13 in 1978, the median house price in California has increased from $70,890 to $811,170 a more than 10x increase, while real property taxes have inched along at 2% or less per year. Obviously, this tax structure rewards holding real property for a long period of time. Most famously, Disneyland’s 85 acres in Anaheim, CA is assessed at its 1975 property value, which is estimated to be saving the company $25.8M per year in real property taxes.

So, when do property taxes increase?

Property taxes in California are adjusted or “reassessed” upon a “change in ownership”. A “change in ownership” occurs when there is a “transfer of a present interest in real property, including the beneficial use thereof, the value of which is substantially equal to the value of the fee interest.” Rev. & Tax. Code, §§ 60.

This seems simple enough. For the vast majority of transactions, real property reassessed upon sale to a third party. Therefore, the new buyer takes the property with a base year value substantially equivalent to the current fair market value at the time of purchase.

However, the analysis gets more complicated when we look at some slightly more complex planning strategies. We often advise clients that hold real property in an LLC. This structure, if done correctly, can result in isolating liability related to that specific real property in the LLC rather than exposing all of their personal assets to liability.

Legal Entity Ownership of Real Property

Legal entities such as a limited liability companies or corporations are considered separate legal entities for the purpose of most legal transactions. Meaning, a transfer of real property from an individual to an LLC or corporation will result in a “change of ownership” and trigger reassessment of real property taxes to current fair market values. This could be disastrous for a client who has held real property for a long period of time and suddenly sees a substantial increase in their real property taxes.

Exceptions

However, there are exceptions to the change of ownership rules that can be used to avoid a reassessment.

1) Proportional Interest

This is the most common exclusion used in the context of transfers to legal entities. This exclusion says that if the pre-transaction percentages of beneficial interest are the same as the post-transaction percentages of beneficial interest there is no “change in ownership”. For example, an induvial can transfer real property to an LLC owned 100% by the individual and there will be no “change in ownership”. This rule applies to as many owners as needed. The key is that the percentages before and after must be exactly the same.

2) Interspousal/Registered Domestic Partner Exclusion

A transfer between spouses or registered domestic partners is not considered a “change in ownership” and will not result in reassessment.

3) Transfer of only bare legal title

Transfers of legal title without the beneficial use is not a “change in ownership”. For example, a transfer of real property to a trustee of a trust is not a “change in ownership” as long as the current beneficiaries of the trust are the owners of the real property before the transfer.

These exclusions are valuable tools for planning and if used properly can result in substantial benefits to the property owners. However, each exclusion must be affirmatively claimed by completing the appropriate form published by the California Board of Equalization and submitted to the County Assessor at the time of recording. Before deciding to transfer real property to a legal entity consider the potential ramifications for your real property taxes.