Property Tax Primer
In California people worry about taxes of all sorts: income, estate, and gift. But I think the one that causes the most angst in my office is actually property tax, because almost everyone worries about having their tax rate reassessed, and greatly increased, upon the death of a parent or spouse. Because of Proposition 13, passed in 1978, property taxes in California are limited to an assessed value that's established when you buy your home and the growth rate of future assessments is limited to the lesser of inflation or 2 percent of that assessed base value.
What this means in English is that once you purchase your home, your property tax rate is limited by the amount that you paid for that home plus a modest increase over time. As housing values have gone through the roof in Silicon Valley, this assessed value is much, much lower than the fair market value of a home. For example, someone who bought their house in 1953 in Portola Valley for $53,000 is going to be paying a fraction of the property taxes that their neighbor, who works at Google, and paid $3.5 million for the house next door, is paying. (In case you were wondering, for people who purchased their homes long before Prop 13 passed, the base value was set at that property's value in 1975).
Once properties are sold, new assessments are set by the current value the properties. Property taxes are reassessed when there's been what's called a "change in ownership." Again, what this means in simple English is that a new owner is going to pay a whole lot more in property taxes than the previous owner. So, a change in ownership for a family residence is cause for concern.
The good news is that most transfers between parents and children (and also between children and parents) are excluded from reassessment. When a parent dies, they can transfer their principal residence (of any value) and up to $1 million of other property to their children free from reassessment. And that "up to $1 million" in other properties is valued using the value the assessor uses to calculate property tax (called the factored base year value), not the fair market value, of that property. The base value is the purchase price plus a modest annual increase. It's not the fair market value if that property was purchased a long time ago.
This means, for example, that a mother who owns five rental properties that she purchased in the 1960's and 1970's, with a current market value at well over $5 million, can transfer ALL five properties to her children free of reassessment because the factored base year value of all five properties adds up to only $300,000.
Exclusion from reassessment, however, isn't automatic. Once there's been a change in ownership, the new owners need to file a claim form to explain why they should be excluded from reassessment. Transfers between spouses and transfers between parents and children are among the reasons listed, and it's just a simple check box to fill in. If the transfer is as a result of a trust, the assessor wants a copy of that trust. A party has three years to file such a claim, unless they receive notice from the assessor that they need to file the claim sooner. Lately, my clients have been receiving letters asking for such a claim to be filed within 15-30 days of receiving the letter, and if they don't, their taxes will be reassessed. Needless to say, these letters are upsetting and seem overly aggressive on the part of the county assessors, since transfers between spouses and children are clearly excluded under the law from reassessment.
Finally, when siblings inherit property equally, but only one sibling wants the house, avoiding reassessment can be difficult, and sometimes is not possible. If one sibling can get the house, while others can get an equivalent amount of other trust assets, that's not a problem. The assessor will want to see the appraisal and a spreadsheet showing that each beneficiary got an equal amount of trust assets. They will interpret this to show that there was a transfer from parent to child for the house and taxes won't be reassessed.
But if there are not sufficient assets in the trust to make this work, and one sibling still wants the house, that is a problem. For example, if a father dies and leaves a house valued at $1 million to his three daughters and other trust assets worth $500,000, if one daughter wants the house, there won't be sufficient other assets in the trust to avoid reassessment. Here's why: the assessor will describe this transaction as one daughter buying 1/2 of the house from her siblings, since each daughter was entitled to $500,000 worth of trust assets (1.5 million total/3). Since transfers between siblings are not excluded from reassessment, 1/2 of the house will be reassessed at fair market value. The 1/2 that the daughter inherited from her father is not reassessed. It is sometimes possible to take out a mortgage against the property to reduce it's transfer value and make such a transaction from siblings work to avoid reassessment, but such loans are difficult to negotiate because the property is held in an irrevocable trust, so it can't secure the loan.
If you or anyone you know or work with is inheriting a house, and has questions and concerns about the property tax implications of the transfer, feel free to get in touch or to share this article with them.