Exemptions to Increased Property Taxes
With estate planning, one of the primary goals is to minimize the costs, especially taxes. There are many types of taxes to consider, such as income, estate and generation skipping taxes. When real property is involved, estate planning also includes minimizing real property taxes. Although the amount of real property taxes is not as dramatic as typical estate taxes or capital gain taxes, property taxes are paid year after year. Since real property is the primary source of wealth for most estates, it is critically important to minimize real property taxes by avoiding reassessment wherever possible.
With the passage of Proposition 13 some thirty years ago, the taxing authorities are limited to increasing annual property increase of two percent (2%) per year unless there is a “change of ownership”, namely a transfer or sale. Upon a transfer or sale, real property taxes are reassessed at one percent (1%) of the current fair market value. A house purchased twenty years ago for $175,000.00 may have property taxes of $2,500.00 per year. If there is a “change of ownership” today those taxes could easily be in excess of $12,000.00 per year. How then can we plan to avoid increases in those taxes?
The statutes that regulate property taxes include many exemptions from reappraisals. When an estate includes real property, proper planning should include the use of these exemptions whenever possible. The most commons exemptions are discussed below.
- Inter-Spousal Transfers:
Any transfer between spouses is excluded from “change of ownership.” This exclusion is especially useful to transfer assets to take full advantage of each spouses estate tax exemption of $1,500,000.00. These transfers also include transfers to a trust for the beneficial use of the spouse.
- Trust Transfers:
Any transfers to trust, either revocable or irrevocable are exempt from reappraisal if the transferor, and/or their spouse is the sole present beneficiary. For example, transfers of real property into a family living trust avoid reappraisals of property taxes.
- Transfers to Legal Entities:
Transfers to or from legal entities such as corporations, limited liability companies or family partnerships are considered “changes of ownership” unless the transfer merely changes the method of holding title and the proportional interest of the owners remain the same both before and after the transfer. The proportional interest must remain the same in each and every parcel transferred. For example, if the family owns several parcels of real estate and transfers those to a limited liability partnership, each parcel must have been owned in the same percentages as the limited partnership percentages.
Another variation on transfers regarding ownership interests and legal entities is the sale or transfer of either stock or a partnership interest. So long as the transfer is less than a combined 50% interest in the entity, then no reappraisal occurs.
- Parent-Child Transfers:
Parents may transfer to their children the principle residence and up to one million dollars in other real property without triggering reappraisal. The one million dollar value is based upon the assessed value on the tax records immediately prior to the transfer. Children for purposes of the statute include stepchildren, the spouses of children and children adopted before the age of 18.
- Grandparent-Grandchildren Transfers:
Grandparents also have the same exemption as parents, namely their principle residence and up to one million dollars in other real property. This exemption is available only to the extent that their grandchildren did not already receive such property directly from their parents.
- Seniors Transfers:
If the seller of real property is at least 55 years of age, the seller can transfer their tax base into a replacement residence purchased or newly constructed within two years before or after the sale of the original residence. The replacement residence must be “equal to or lessor” in market value than the original residence. In other words, as long as the replacement property does not have a market value more than the original residence, the property taxes can be transferred to the replacement residence.
This exemption is only available once in a lifetime, and is designed to encourage a person age 55 or over to “move down” to a smaller residence.
With estate planning, don’t forget to include planning for minimizing property taxes. Those annual payments can add up to a larger sum than either estate or income taxes. As long as California maintains its current property tax system, this planning is an essential component to maximizing wealth.