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Pretty much all California real estate owners are aware of Proposition 13, the benefit granted to existing real estate owners, restricting property tax increases to a maximum of 2% per year.  Many real estate owners are also aware of Proposition 58, which provides a “parent-child exclusion” from the normal rule that eliminates Proposition 13 protection from any change in ownership.  Proposition 58 allows parents and children to transfer properties to each other as gifts, or at death, without reassessment, so long as proper paperwork is filed with the county assessor.  This protection is given to a primary residence (of unlimited value) plus up to $1M in assessed (not appraised) value per spouse.

 

One tricky issue that clients are NOT often aware of is that the assessor’s office makes a very nuanced distinction between real estate that is eligible for “parent-child exclusion” protection and real estate held inside entities such as limited liability companies (“LLCs”) that are NOT eligible for that protection.  It’s hard to believe because it defies common sense, but that’s right – property held inside an LLC will not be eligible for protection from a property tax increase if the LLC is transferred to the children (rather than the underlying property).

 

Let’s use two examples – in the first example, the parents WILL be able to provide Proposition 13-style protection to their children; in the second example, they will not.

 

Henry and Wilma purchase an investment property on Candy Lane in 1999 for $500,000.

  • The property tax is approximately $6,000 per year and goes up each year by 2%
  • Henry and Wilma have a trust that says all of their assets, including their property on Candy Lane, are to go to their son Sam.
    • Henry and Wilma transfer title to Candy Lane to themselves as trustees of their living trust.
  • Henry passes in 2015 and Wilma passes in 2020, at which time the value of the property is $1.5M but the property taxes are only $9K per year (if they were taxed at current market value, they would be 2x that)
  • Sam becomes owner of Candy Lane.
  • He works with Kaiser Law Group to file the proper forms with the county assessor
  • The Candy Lane property will NOT be reassessed.  Sam will pay property taxes as if the property is worth closer to $750K than the fair market value of $1.5M

 

Henry and Wilma purchase an investment property on Candy Lane in 1999 for $500,000.

  • The property tax is approximately $6,000 per year and goes up each year by 2%
  • Henry and Wilma establish Candy Lane, LLC to hold the Candy Lane property and protect against unexpected lawsuits; they retitle the property into the name of the LLC.
    • Since the LLC is owned entirely by Henry and Wilma, there is no reassessment.
  • Henry and Wilma have a trust that says all of their assets, including their Candy Lane, LLC, are to go to their son Sam.
  • Henry passes in 2015 and Wilma passes in 2020, at which time the value of the property is $1.5M but the property taxes are only $9K per year (if they were taxed at current market value, they would be 2x that)
  • Sam becomes owner of Candy Lane, LLC
  • The Candy Lane property WILL be reassessed.  The property taxes will jump from approximately $9k per year to $18k per year
    • Why??  Because the LLC was transferred from Henry and Wilma to Sam – not the property itself.

 

This seems like a dramatically unfair result – and it is!  But those are the rules…so our clients need to be aware of them.

 

What are our options to consider for families who have California investment properties with low property tax basis in an LLC?  If they want to transfer the property(ies), to children, they can:

  • Leave the properties titled in the LLC. Upon the passing of the parrents, all properties will be fully re-assessed. This is a really bad option from a tax perspective, but in certain circumstances may be worth considering due to the protections the LLC provides.
  • Leave the property outside of the LLC (Such as titled in the name of a revocable trust) only if the benefits of keeping the low property tax outweigh the protections an LLC provide during the parents’ life.
  • A middle ground to keep substantial protections is to circle a date on the calendar (e.g. 1/1/2029) and remind yourself to evaluate your family situation and transfer the properties out of the LLC at that time.
  • A risky/aggressive approach, is to wait until the Mom and/or Dad are elderly or in failing health, then pull the property(ies) out of the LLC at that point in time.   If our client guesses wrong however, it can be a costly choice.

 

There are advanced techniques we can use to minimize the taxes in these situations, but this blog post is just to alert you to the issue so that we can discuss it with you.

 

Bottom line:  If you have (1) California investment properties (2) with low annual property taxes (3) that you plan to someday give to your child/children, you need to understand that for all of the benefits an LLC provides, property tax protection is not one of them.