Three Ways to Save Your Heirs Thousands in Property Taxes

In California, a person’s property tax base may increase by only 2% per year, unless a change of ownership is recognized. This bodes well for children of owners: parents can pass a house on to their children without acknowledging any change in ownership. The effects can be significant. For example, let’s say Bill Parent bought his house in California in 1979 for $300,000. Annual property taxes are set at 1% of the cadastral value, which can increase by only 2% per year. Therefore, property taxes, which were $3,000 per year in 1979, would be only $5,434 per year in 2009, assuming the maximum 2% base increase was imposed. Today, the house is worth $1.2 million.

If a change of ownership were recognized, the new owners would start with $12,000 in annual property taxes! However, if Bill Parent sells the house to his son, or leaves the house to his son by will or trust, no change in ownership would be recognized and the son would save thousands of dollars annually by inheriting the basis. tax on your parents’ property. Well-meaning parents often miss the reevaluation exception without realizing it. In this article, we explore three ways the reevaluation exception can be missed and what to do about it.

1st mistake: the purchase

Bill Parent decides to write his will, in which he gives his assets to his two children, Timmy and Tammy, equally. Upon his death (Bill Parent was a widower), neither Tammy’s nor Timmy’s 50% interest in the house will be reassessed. However, Timmy wants to “buy” Tammy out of the house from him. While Bill Parent wanted everything to be the same, which two brothers can share a house? Unfortunately, since there is no sibling-to-sibling exception to revaluation, the 50% share that passes to Timmy will be revalued to its current value. This would leave Timmy with an $11,434 property tax bill instead of a $5,434 bill.

There are several ways Bill Parent can avoid making this mistake. First, he can give the house to the child who needs it most. The problem with that approach is that the final distribution of assets might not be equitable. He also may not know who would need the house the most at the time of his death. Second, he can create a revocable living trust, giving the trustee discretion to make non-pro rata allocations of all assets in the trust. This allows the trustee to give the house to one child and the remaining assets to another, as long as the final values ​​are equal. The problem with this approach is that there may not be enough assets in the trust to match the distribution. Consequently, the trustee may have the discretion to mortgage the house. The house passes to Timmy, retaining full exemption. The proceeds of the loan are passed on to Tammy, matching the transaction. At the end of the day, Timmy retains the low property tax base that Bill Parent enjoys, and Tammy inherits assets of equal value.

2nd Mistake: To my close friend, for his life

Bill Parent’s wife passed away years ago. Her close friend Renée has been her trusted companion for the last few years of her life, and Bill is Renée’s main financial supporter. Renée is old and Bill doesn’t know who will die first. Bill wants to make sure that after her death, Renée is well provided for if she is still alive. He writes his will, giving Renée the right to live in the house until her death, after which the house will pass to Timmy and Tammy. Bill Parent doesn’t know much about property law, but he heard from Tammy, a law student, that a life estate doesn’t equal “freehold.” Therefore, Bill Parent believes that the house will not be reassessed as Renée will never fully “own” the house.

When Bill Parent passes away, Renée lives on. The house will be reassessed because Renée will be deemed to have received a “current interest” in the property, and there is no exception for transfers to close friends. Although Renée does not own the house in “absolute simple installment”, she does have the right to immediate possession. Under California law, that is enough as a change of ownership and the new property tax base will be $1.2 million. When Renée passes away, the children will face the entire property tax bill.

Unfortunately, it will be difficult to give Renée any rights to the house without losing the reassessment exception. Bill can support Renée, however, by setting aside assets other than the house in her trust and giving the trustee the discretion to pay the income to Renée during her lifetime, with the principal passing to the children after her death. her death. This alternative achieves Bill’s goal of financial support without sacrificing the parent-child exception to reevaluation.

3rd mistake: transfers to grandchildren

Tammy graduated from law school, pursued a successful career, and now has her own daughter, Tasha. Bill Parent would like Tasha to keep the house since her two children now have houses and Tasha is the one who needs it the most. However, Bill Parent realizes that he would lose the parent-child exception to reevaluation. Accordingly, he writes her trust, as long as Tammy has the right to buy the house, after which she will be required to immediately sell the house to Tasha. Bill Parent pats himself on the back: this way, he figures, he’ll take advantage of two parent-child exceptions. He believes both transfers will preserve the low property tax base.

Unbeknownst to him, a rule called the “tiered transaction doctrine” will treat a set of transactions as a single transaction if the purpose was to avoid tax. Because Bill Parent’s trust explicitly requires Tammy to transfer the house to Tasha, the intent to avoid reassessment seems clear. Therefore, Bill Parent should not demand that Tammy sell the house to Tasha. Unfortunately, there is no clear law about how long it takes before Tammy can sell the house to Tasha while she preserves her own father-son exception. Bill Parent, and later his trustee, must consult with an attorney to ensure that a sale does not unknowingly trigger the staggered transaction doctrine.

conclusion

Prop 13 has allowed property owners to transfer real estate to their children with a low property tax base. However, several common errors before the parent-child exception. It is always a good idea to consult an attorney when preparing a will or trust, or handling the estate of a deceased person. A little good advice can save your heirs thousands of dollars in property taxes.

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This article is intended to provide general information about estate planning strategies and should not be considered a substitute for legal advice from a qualified attorney. Treasury regulations require a disclaimer that, to the extent this article pertains to tax matters, it is not intended to be used and may not be used by a taxpayer for the purpose of avoiding penalties that may be imposed by law.