HilaryLThere has been a lot of talk lately about repealing parts of Proposition 13.   Passed in 1978, under this initiative, property tax increases are severely limited. The resulting loss of tax revenues was devastating to the public school system and other infrastructure in California.  Democrats who now have a supermajority in the state legislature are looking at their supermajority as an opportunity to turn that around.   In addition, recent polls show that a majority of Californians are in favor of a repeal of Proposition 13 as it relates to commercial (non-personal residence) properties.  For an extended read about the recent polls of Californians who are in favor of a repeal of Proposition 13 see the following SFGate: Poll Finds Support for Prop. 13 Change .

In addition, Proposition 13 has recently even come under attack by its usually staunch supporters due to a perceived abuse of loopholes (See LA Times Article).   In response to this perceived abuse, Assemblyman Tom Ammiano has introduced a bill to plug the “loophole.”

The basic rule of Proposition 13 is that increases to the property tax are limited to not more than 2% each year until sold or otherwise transferred, for example by gift or inheritance;  such sales or transfers are referred to as a “change of ownership.”  It is not quite that simple, however.  Property passed to children under the parent/child exemption is exempt from reassessment for a home regardless of value, and for other property up to $1 million in assessed value. Assessed value is the amount for which property is assessed on the property tax bill, not the fair market value of the property.  Since property tax increases are so severely limited under Proposition 13, that $1 million exemption can cover a lot of property if the property has been held for a long time.

In addition, if property is held in an entity,  such as a corporation, partnership or LLC, then until more than 50% of the property changes hands, or one person gains control (obtains more than 50%), transfers of interests within the entity are not deemed to be a “change of ownership.”  The parent/child exemption does not apply to these transfers; so once more than 50% of the entity is transferred to the children, or one person obtains control, there will be a “change of ownership” and a reassessment even if the interests do pass to children.

There are many cases where even the $1 million parent/child exemption will not avoid reassessment.   And there are often situations where property is held in an LLC for asset protection, and so the parent/child exemption will not exclude the property from reassessment upon the death of a parent.

However, through the use of entities, with some restructuring steps taken, as evidenced by the situation referred to above that has outraged even Prop 13 advocates, it is possible to transfer a great deal of property free of reassessment.

For example, if a parent owns 50% of a $10 million building (and two or more children own the other 50%), assessed at $10 million, the $1 million parent/child exemption is not going to be very useful.   If, however, the parent and children put the property into an LLC, then when the parent dies there will be no reassessment because not more than 50% has changed hands, and no one has obtained “control.”   This is but one of many strategies we are using to avoid reassessment of real property when property passes to children.