California Property Taxes, with Ryan Lockhart
Welcome to a special edition episode of I Know a Lawyer. In this episode, I, Ryan Lockhart, go solo in order to convey certain key pieces of information about California Property Taxes. In the episode, I discuss:
Prop 58: The Parent-Child Transfer Exclusion
Entity rules with respect to property tax reassessments
Two sub-rules for entities to know in order to mitigate reassessment
Prop 15 on the November ballot
Thank you for listening to this special solo edition of I Know a Lawyer. Next week, we will return to our original programming. If you have any questions about property taxes and any of the sub-topics I discussed in this episode, contact me at 925-433-5447 or through our website: mckennabrink.com.
I Know a Lawyer is brought to you by McKenna Brink Signorotti LLP.
Transcript
Ryan Lockhart (00:00):
Hello, everyone. Welcome to a special edition of, I know a lawyer. I'm Ryan Lockhart, I'm the host. And in this episode today, it's just going to be me. So we're going to call it a solo episode. I did one of these in the beginning, and I always want to kind of come back to this topic. I'm about to talk about today and that's California property taxes, basically if picked up in September and thought, you know what, I'm going to kind of stump for the property taxes just to basically educate other people. Cause I get it. I've been getting a lot of questions about property taxes and some certain key issues that tend to arise. So that's what we're gonna talk about today. Just basically me talking to you about some property taxes and yeah, I hope you enjoy it. At least get something out of it.
Ryan Lockhart (00:48):
So, alright, so let's talk about California property taxes and that, let me back up, as you know, this is this podcast is brought to you by McKenna Brink Signorotti check us out at mckennabrink.com and you can see all the different practice areas that we cover. And so that'd be good for you to check out and obviously continue to support the podcast is great. So if you're listening to this episode on any of the podcasting apps, Google podcasts, Apple, any of the various ones, if you hit subscribe and then you can catch all the new episodes as they come out, that'd be greatly appreciated. Plus you never know you might learn something. I know there's been some pretty good episodes that I've done that people have actually learned. I've gotten some feedback that they've learned some, some different aspects of the law that they otherwise did not know.
Ryan Lockhart (01:35):
So that's what the whole idea is about anyways. All right. Property taxes. What do you want to, what should I tell you about property taxes? Well, let's start with some basics. So in California, we are pretty familiar with prop 13. So prop 13 came in and late seventies and basically capped property taxes at 1% of the assessed value. Whenever an acquisition happens, there is an annual increase of about 2% of the assessed value each year. So, but it's pretty small thing, small incremental increase that happens cheer on your property tax bill. So yeah, this is a good reminder at this time to say, take a look at your property tax bill, are you, do you understand what it really says? They usually break it up this as far as the value as land and improvements, you know, so land is the actual dirt let's call it.
Ryan Lockhart (02:25):
And then the improvements are basically the structure that's built on top of it. That totals up to be basically what they call your factored base year value. So your factored base year value is what the assessor, the County assessor is going to do have on their roles, the property tax rolls. And, you know, that's where they're going to do that little 2% increase each year. And the County is obviously looking to see if a transfer of the property happens. Cause if there's a transfer that can trigger it, right, a reassessment, then the County gets to reassess the property. Obviously they're going to want to do this. It's going to increase property taxes on that property. And they're going to increase revenue for the County basically. So think about your primary residence or maybe even some other properties that you own. Those could be like a vacation home or commercial properties or, you know, residential rentals that you rent out.
Ryan Lockhart (03:24):
All these are basically kept under prop 13 based on the value of when you bought it. And so what I wanted to talk about today really is two main topics and kind of a third one, I'll jump into a little bit at the end, but really the two main topics are one, the parent child transfer under prop 58, people have heard about prop 58. And what it effectively does is it allows a parent to transfer their factored base year value in their property, down to their children. And the children are basically going to inherit their parents' property tax bill. So that's pretty nice benefit, right? It was put in under prop 58, I think back in the eighties. And I'm going to dive into that a little bit here in a second topic. Number two, and really the meat of what I want to talk about today is what I call the entity rules.
Ryan Lockhart (04:16):
This comes into play with any sort of legal entity that owns the real property. Most likely it's partnerships or LLCs limited liability companies, sometimes corporations. But there's some couple of specific rules about transfer of the entity interests. And when that triggers a reassessment kind of a big issue, especially when you're talking about LLCs, dissolving partnerships, resolving people, kind of going through, you know, the business partners go in their separate ways and they had some real property in that partnership. Maybe that was the business real property investment. So you basically just don't want to trigger reassessment or mitigate the property tax hit as much as you can. And there are very specific ways of going about that. So that's the topic. Number two, I'm a dive into a little bit later. So let's back up to topic. Number one, really. And that's that parent child transfer under prop 58.
Ryan Lockhart (05:13):
So what is prop 58 say, well, effectively prop 58 says a parent can transfer their factor based your value to their child. And as long as it's a direct transfer from a parent to a child, or it can be from parents to a child or multiple children then they won't reassess the property. It's a property tax exclusion or exemption, and there's a form called a prop 58 form that gets filed as long as it's filed within three years of the transfer, then the County, you know, will not reassess property effectively though. They are going to try to reassess it earlier until they get that form. So get the form in pretty soon after you do the transfer, just to make sure that it's gonna run smoothly and you're not trying to walk back a potential or at least a proposed reassessment from the County.
Ryan Lockhart (06:03):
So there's other, there's some specifics in a Prop 58 transfer as well. So if it's a transfer of the parents, principal residence, principal, or primary residence, then that's basically an unlimited exemption. It doesn't matter what the value of that residence is. If it transfers from parent to children, it's exempted, that's easy. The other one, and not everybody knows this from, you know, talking to clients and even other attorneys is that basically California residents can transfer up to $1 million of what they call other property. So this could be your vacation, home or residential units that you're renting out or commercial property. The $1 million number is applied, or let's just say, it's the actual factor base your value or call your property tax basis. So mom it's, if you have a husband and wife and they want to transfer a Tahoe vacation home, that's on the California side of Tahoe, they want to transfer that to their children and it's worth $2 million, but they bought it 10 years ago at $1 million.
Ryan Lockhart (07:17):
Let's just say, well, their property tax basis is probably close to that $1 million number or there's that little 2% increase each year. So just a little bit more than a $1 million property tax basis. And so they can transfer that entire property to their kids. And effectively only use 1 million of their collective $2 million exemption under prop 58, because this is an other property. It's not their primary residence. Let's say different example. Mom and dad have five different pro residential units that they rent out right by different houses or condos or townhouses or something like that. And let's say they look at the five different ones and they kind of total up their factor, base your value for all of them. And it comes in at $2 million. Well, because mom and dad each have a million dollar of exemption under prop 58. They can effectively transfer all five of those residential units to their children and exempt all of them from property tax reassessment under the parent child transfer.
Ryan Lockhart (08:21):
So it's very powerful to use this and leverage it as much as possible. Sometimes we have to look and see where we're going to get the biggest bang for our buck. If they switch it, there's multiple properties that the family owns and we're looking to gift certain ones like we'll, you know, we'll look at also the value of those properties, but we'll additionally look and analyze like what's like the real property tax benefit we can get out of this under prop 58, because once they, the County gets to reassess the property, obviously property tax bill gets it's going to jump, especially if property has been held for a long period of time and the property tax bill is really low. So, you know, the County would love to reassess that, jump that number up, get more property taxes, and it's going to be an annual, you know, once you get reassessed, it's going to be a hit basically every year after that, right?
Ryan Lockhart (09:13):
You might, you might be paying a $5,000 a year property tax bill, and if they could reassess it and it turns into $15,000 a year, that's, you know, that's $10,000 more a year, you know, and also subject to that little 2% increase. So it's, it's important that we at least look at property taxes. That's why I'm out there in my networking groups. And I'm meeting other professionals and say, look, let's, if you're doing real estate transactions let's take a look at the property taxes because it's important. And sometimes we don't want to overlook it and we can actually save the client some money. So, so that's that topic. Number one, talking about prop 58, it's pretty, pretty easy to analyze, and it's definitely easy to apply. You do basically just do the form, send the form into the County assessor's office. The assessor will probably ask for some backup documentation, but that's relatively easy to show.
Ryan Lockhart (10:03):
And they basically say we're the parents, here's our children, you know, that the deed that was recorded and we qualify. And so that's great. So the County will apply that exempt, that transfer, no reassessment is going to happen. Awesome. Let's talk about topic, number two, the entity rules. So these are kind of little tricky and, and definitely not a lot of people know about these. So it's really kind of impetus of what I want to talk about today. This is kind of in my mission a little bit to educate people on this, because this also applies not only in, we want to call it like business dissolution, that entity dissolution, but also like in 10 31 exchanges where some partners are going to be going their own separate ways. There's some property tax analysis that should happen just to make sure that we're accounting for it.
Ryan Lockhart (10:55):
And we can mitigate property tax reassessment if available, right? It's at least worthy of an analysis to see if we can, you know, save on some property taxes, so let's get into it. So there's two different rules sub-rules to these entity rules. One is what they call change of ownership. So basically the laws in this area say if an entity changes ownership, then that's going to trigger a reassessment. Now, normally if there's a change of ownership in an entity, they will trigger reassessment to all properties held by that entity. So it could be a huge impact if you have an LLC that owns five different properties and there's a change of ownership and we get into what that means, then it would trigger reassessment and all five of those properties. So it's a big one, right? Especially at these LLCs or partnerships, been holding property for a long period of time.
Ryan Lockhart (11:53):
So what is change of ownership? Well, basically it says somebody, somebody gains control of the entity, so they can, it's called the change in control or change of control triggers, a change of ownership, the change of ownership triggers a reassessment. So let's say for example, we have an LLC and there's four members, you know, four partners in it and they all own 25% each, right? Nobody has a controlling interest. So they've been operating this way for 20 years and, you know, two of them decide they're going to sell their LLC interest to this certain partner of theirs. So there's one partner is going to go from 25% to a 75% member. Once he gets to that 75% number, he's crossed that more than 50%, I'm controlling interest threshold that triggers a change of ownership because he's now in control through the change of control.
Ryan Lockhart (12:58):
And that would trigger a reassessment on all the properties held by the LLC. Well, what if that's what look at that example a little further and say, well, what if they, he only bought, you know, 24.9%, right? So he's going from 25% to 49.5%. Would that be a change of a control, triggering a change of ownership triggering a reassessment? Well, no, it wouldn't because most likely if he's at 49.5, there's other people that represent that 50.5% interest or whatever, 51% that can technically outvote him. So there's no change of control there. So that's, you know, it's something that we definitely plan for when we're doing these types of planning. When in like family owned entities where the family has an LLC or a partnership that owns real property, and we're trying to maybe give some assets down or at least interest in the entity down to the children, but we don't want to cross this 50% threshold.
Ryan Lockhart (14:08):
So that's change of ownership, right? So that's one rule. Number one, we're going to talk about, well, I guess we just did a number two, it's called the I'm gonna call it the original co-owner rule, slightly different, but we're still dealing with an entity. So we have an LLC or a partnership, and this is more about capitalization. So if you have a partner who contributes real property into the entity and that's, he's going to be what they call it an original corner. So let's take these things. I'm going to go through this example. I think it'd be easier to understand you have three different people are going to form an LLC and they're going to contribute one property each, right? They all own these different properties. They want to put them into this LLC for like co-management experience, you know, reasons. So that's what they're gonna do.
Ryan Lockhart (15:00):
Alright. So they all contribute them into the property or the LLC. They are all original owners of each of those properties. And so effectively they're going to be tracked separately once. And the rule says once cumulatively, more than 50% of the interest in that property that got contributed into the entity transfers, right? So let's say partner A contributes in property. And then through his own estate planning transfer to 70% of that property or that his LLC membership interests to his kids? Well, that could effectively cross that 50% threshold of the, his original ownership,utracking in that property. And it would trigger a reassessment, but just on that one property. So it's pretty interesting to,uyou know, track separately, cause it's a little bit different than the change of ownership and change in control scenarios. So you could actually have both, right?
Ryan Lockhart (16:07):
So you could have three, three partners in a partnership and one of them gains a controlling interest and it's one cumulatively more than 50% of those interests have transferred since they originally founded the entity. And we have a change of control scenario, which is going to trigger change of ownership. So under both rules, you're really going to get triggered with reassessment and effectively all the properties in that partnership are going to get reassessed. So this is like a tricky set of rules and it's really case by case and client specific. So I get, I've been getting questions about these rules quite a bit over the last couple of years. And it's really about partnerships and LLCs with multi members, multiple partners, just trying to move some of the partnership or the entity interests to each other, either through a sale or, you know, through a gift or they're on estate planning, but they're trying to avoid triggering these reassessments that they can.
Ryan Lockhart (17:06):
So sometimes what we do is we'll drop the property out of the LLC or the partnership. And this is easier to do in an LLC or a partnership than it is in like a corporation, right? Because dropping the property, you have a corporation, even if it's an S Corp is going to have some income tax implications. But if it's an LLC, let's say drop the property out, move some of the actual property interest directly between those partners or even through kids and estate planning. And that's how we can mitigate, you know, potential reassessment. So instead of triggering a full reassessment of the property, maybe we just trigger a portion of it because the actual portion that transferred and then just have everybody rolled into a new LLC or a new partnership and then kind of go on their merry way. So these are different planning techniques that we can employ or at least analyze and see if it's available.
Ryan Lockhart (17:58):
And, you know, don't, don't get caught off guard with these entity rules, especially the original co-owner one. Cause that's the one I think is the least known. People kinda kind of understand the change of control, change of ownership. You know, somebody gaining control the interests, the County basically looks at, it says, well, that's basically the new owner, right? So there was a transfer. Now we can reassess this a colon or one is a little bit tricky. So it definitely takes an analysis and highly recommend if you have questions about that, reach out and we can at least run through it. So that's basically sets up the entity rules kind of a quick and easy primer on it. Like I said, it's a case by case specific, so it would need some analysis, but let's talk a little bit. So there's like I did say there was like a basically topic number three, right?
Ryan Lockhart (18:50):
Well, topic number three is real quick is let's talk about prop 15. Prop 15 is what's coming in in November election and this is going to change prop 13. It's confusing. So prop 13, everybody knows it as prop 13 because it was called proposition 13 back when it was passed in the seventies. So this new proposition that's on the ballot in November, it's called prop 15 and it's a proposal that's up for people to vote on. That's going to tax commercial and industrial property valued at more than $3 million. So I'm actually gonna read something real quick, right off the secretary of state website about the proposition proposition 15 and just basically quick language about it, what it does. So it talks about it's supposed to increase funding for K through 12 public schools, community colleges, and local governments. And it's going to require that commercial and industrial real property be taxed based on current market value.
Ryan Lockhart (19:49):
So what is effect will be doing is removing the prop 13 protections from commercial and industrial real property. The proposition says that it exempts residential properties. So that's homes agricultural properties, you know, farming let's think and owners of commercial and industrial properties with combined value of 3 million or less. This is just the language that's on the proposition right now being voted on. Obviously if it's passes, there's a lot more that has to get explained and kind of flushed out. Cause there's some definitely some gray area about what those terms mean. I think so we'll see what it says, combined value with 3 million or less. So are they gonna look at total value of the person that owns these properties or is it just $3 million or less in that specific property? I don't know. You have to run through the summary and see how this is actually be implemented.
Ryan Lockhart (20:41):
If it got passed, I have a feeling it's going to be a little bit different than people might expect, but that's on the ballot, this coming November. And this is kind of the first, you know, target on prop 13, they're going to target commercial and industrial properties and it definitely exempting residential, they say, but you know, it's kind of like slippery slope potentially, but we'll find out. So I just wanted to let people know that that is definitely on the ballot. So take a look into that and, you know, send me your thoughts if you want to, I'd be happy to kind of talk to you about that. Cause I have definitely been getting these questions as well. Well, what happens if this proposition passes as well? We're going to find out because if it gets passed, I think that some of these counties are one they're going to have to beef up their staffing.
Ryan Lockhart (21:29):
So there's issues they're bringing in some, you know, their own appraisals beef up their appraiser departments and have to go through these commercial and industrial properties and basically reevaluate, revalue them up to current fair market value, but in a Covid environment, like there's going to be challenges there too. So I don't know we're going to be find out, I think it's worth tracking and it definitely ties into why I wanted to talk about these different rules, especially the parent child transfer and a prop 58 and the entity rules specifically that original coowner rule and just, I don't want people to get caught off guard. If you're looking to do some sort of planning where you're going to do some transfers of property to children or potentially entities, partnerships, LLC interests to children, your estate planning, or you're just looking to sell or buy from another business partner that's involved in the same entity, just get some analysis done, just to see if there's a chance and a good opportunity to plan for, you know, avoiding the reassessment altogether or at least mitigated as much as possible.
Ryan Lockhart (22:35):
And then when it's tied into the 1031 exchange side there's some, if you're gonna do like a drop and swap 1031, and if you've never heard of that term, give me a call or email me. I'm happy to explain it because people who have done 1031s do understand, or at least I've heard about the drop in swap technique. And basically what it is is you're in an entity with a bunch of business partners in a bunch, but you have a couple and y'all want to go your separate ways, but you want to do exchanges, separate exchanges. So you have to drop the properties out of the entity, hold it for a period of time. And then everybody does their own separate exchanges. After that, you should do these property tax planning, especially with those entity rules all along the way to make sure you're not, you know, stepping into a landmine there of triggering a reassessment and property taxes before you intend to actually sell it.
Ryan Lockhart (23:28):
Because even though you're going to sell it, you're going to be done with that factored base year value or property tax basis. You don't want to trigger it too early because then you have to just pay an increase in property taxes up until the point you sell it. So again, that's another area where I think property tax planning, effective property tax planning is important. So I don't know. Tell me what you think. Contact me say, Hey, I had some questions about what you talked about on the, on the episode, happy to discuss it with anybody. So again, I'm Ryan Lockhart and this is, I know a lawyer. Thank you for listening to my special solo episode this week. Just a topic I really want to talk about. So I'm glad you listened and stay tuned for a new episode next week and take care everybody.
Bye bye.