Q: The family trust has one piece of real estate in California. If a buyer wants to protect the low Proposition 13 basis, may he or she "buy" the trusteeship and pay the purchase price through the trust to the current beneficiaries?
We're thinking that the buyer loans money to the trust, the buyer then becomes the new trustee, the new trustee distributes the purchase price to the beneficiaries. The trust still has complete title to the land and its low tax basis, and the beneficiaries waive any claims against the trust. My guess is that this is a first-time question, but I'm hoping you have some thoughts on the subject.
A: We're going to start with a disclaimer: Our column can't give you legal advice. For that you'll have to talk to an attorney in California.
But, here's one thought to consider: There's a fine line between avoiding a tax and evading a tax. If you can avoid paying tax, it might be legal, but when you evade tax payments, it's probably illegal.
Our California readers will know this, but for everybody else, here is some context: California Proposition 13 (officially named the People's Initiative to Limit Property Taxation), was approved by voters in 1978. It reduced property taxes on homes, businesses and farms substantially, by around 57 percent, rolling back property values (for tax purposes) to where they were in 1976. Prior to that move, Californians paid property tax at a rate of just under 3 percent of market value, one of the highest property tax rates in the country.
Proposition 13 capped real estate property taxes at the rate of 1 percent of the sales price of the home. Property taxes are only reassessed when the property is sold, and as long as it isn't sold, tax increases are limited to 2 percent. Here's a simple example: Suppose a home was worth $100,000 in 1976. The homeowners paid $1,000 in property taxes after 1978, increasing at a rate of 2 percent every year since. If the home was sold last year for $2 million, the property taxes would be around $20,000.
California may have certain allowances to transfer home ownership to spouses and even children (in the event of divorce or death) that may have a limited effect on assessment of the real estate taxes. And California homeowners may have the ability to transfer the low tax basis from their existing home to a new home they purchase. For example, under certain conditions of other California laws, seniors may have two years to sell their homes and buy or build a replacement property and receive a property tax break.
But it doesn't seem like that's what you're really asking. We read your question as wondering whether you can sell the underlying ownership structure in the home to a third party and keep the low real estate taxes you're currently paying.
In many parts of the country, municipalities have addressed these change of control situations by specifically stating that a change in control of the underlying ownership is considered a sale for purposes of real estate taxes and real estate transfer taxes. If you do some digging, or speak with a reputable real estate attorney, you'll probably find out that California has a change of control provision in its regulations. Otherwise, you'd see everyone setting up trusts and selling trust interests without triggering the increase in real estate taxes.
You aren't the first one to ask this question, by the way. And, kudos on thinking creatively. However, over the course of Sam's law practice, he saw commercial property owners who avoided paying hefty real estate transfer taxes on the sale of commercial properties by doing what you describe but using corporations or limited liability companies instead of trusts. It didn't take long for the local municipalities to cry foul and pass ordinances or rules stating that a change of control in the underlying entity would be equivalent to the sale of the property itself.
We hope this helps.
Contact Ilyce Glink and Samuel J. Tamkin through her website, ThinkGlink.com. (c) 2019 Ilyce Glink and Samuel J. Tamkin