“Proposition 13 of California law has been a major source of property tax savings over the past many years since 1978. But do you know that this benefit can be passed on to your heirs during an intra family property transfer? Under Propositions 58 and 193, your heirs can enjoy the same property tax benefits as you.”
If you are planning an intra-family property transfer, one of the most important things to consider is how much tax liability do you want to incur.
Remember that significant property tax obligations can arise during property transfer transactions including intra-family. Incurring such payments can easily reduce the net transferable amount of property.
Not only this, but they also set a precedent for determining property taxes that your heirs will pay in the future.
Therefore, the first and the foremost important thing is to consult a real estate attorney that specializes in such matters.
A real estate lawyer can help in sorting out matters related to title considerations as well as devising an intra-family property transfer plan. A professionally acquainted plan can maximize the amount of property tax savings. Therefore, seeking assistance from a well-established real estate law firm is the key here.
Furthermore, your real estate attorney can help you transfer Proposition 13 tax benefits onto your heirs, as established by Proposition 58 and 193 of the California law.
In this article, we discuss how Propositions 13, 58, and 193 impact the amount of property tax amounts.
What is an intra family property transfer and dissolution deed?
An intra family property transfer and dissolution is a deed that transfers ownership from one family member to another member of the family. Such transactions only involve a transfer of ownership of assets or property without anything being sold.
In the case of a family member’s death, the entitled and eligible surviving members assume ownership of the deceased person’s interest.
In the case of divorce between a couple, joint ownership shifts from the couple to any one person. This is usually known as dissolution.
The main objective of an intra-family property transfer and dissolution is to take maximum property tax saving advantage. Simply said, this means passing of some tax benefits from the previous owner to the new one.
How do tax benefits transfer from a property owner to its heirs?
Before moving further, it is important to mention the three cases of intra-family property transfers. These three cases also make it possible to transfer tax benefits through an intra-family property transfer deed, as established by Proposition 13.
- Transfer of property to heirs during the life of the original owner in the form of a gift;
- Transfer of property to heirs after the death of the original owner in the form of an inheritance; and
- Transfer of property through a sale agreement between the original owner and the heir. Heirs can use any of the three ways to finance such transactions. Either the heir (buyer) uses his own money to make the purchase. If not, then he can use a third mode of financing such as from a bank. And lastly, by borrowing funds from the seller or using seller finance to carry out such transactions. A loan obtained from a seller is usually considered an ordinary loan obtained from a banking institution.
Understanding the Propositions 13, 58, and 193 of the California law
To understand the scope of tax-saving benefits and how they can pass on to the next owners (heirs) in an intra-family property transfer, let us now discuss each proposition.
Tax benefits under Proposition 13 of the California law
For over 25 years now, the Proposition 13 of the California law has been a major source of providing huge property tax benefits to property owners.
The Californian voters, by passing Proposition 13 in the year 1978, established basic parameters related to property taxes.
Proposition 13 of the California law primarily focuses on three key aspects of ascertaining the property taxes on residential properties. This includes –
- Prescribing the rule for considering the value of a property (current tax basis) for calculating the property tax amount.
- Setting the maximum extent to which a property’s value can appreciate for calculating annual property tax liabilities.
- Suggesting the mode in which a property’s value can adopt a significant change or appreciation, for example using fair market value to calculate the amount of property tax for the current and future years.
How Proposition 13 helps in significantly saving property taxes?
Simply stated, in the absence of Proposition 13, property owners would be subject to a huge property tax burden. Not only this, but the amount of property tax calculated each year will vary unpredictably. This is because of a few valid reasons.
First, property taxes are calculated as a percentage of the value of the property. This means that in places that experience an abrupt increase in property value due to high demand or for any other possible reason, property owners would face huge and highly unexpected tax liabilities.
And second, the manner to ascertain the tax basis for property tax calculation can have disputes.
With Proposition 13, none of the above or any other possible cause of an unanticipated tax burden arises. The tools that Proposition 13 uses for this purpose are the following –
Value of property or valuing the current tax basis
To ascertain this, Proposition 13 recommends using the original purchase value of the residential property. The original purchase price or tax basis is the value at which a property is first purchased.
In the case of old properties, this can turn out to be a huge tax saving advantage for the property owners. By ignoring the huge gap between the base value and the current market value, this becomes possible. While the California law in this regard suggests otherwise, it uses the base value as the current tax basis.
For some properties, there may be instances where the owner might have incurred renovation and/or construction costs during its life. Such costs incurred in subsequent years of purchase add up to the base value for ascertaining the revised tax basis. The revised tax basis will now be used for the current as well as future years for calculating the property tax amount.
Maximum extent of appreciating the annual tax basis
Annual property tax is calculated as a percentage of the current tax basis. The annual increment or appreciation in the tax basis of a property increases by the value of the California CPI (Consumer Price Index).
However, Proposition 13 prescribes that the value of California CPI taken for calculating the current tax basis should not be more than two percent. This again means a huge tax-saving benefit since the actual CPI may be way more than the two percent cap.
A significant change in tax basis
Proposition 13 also suggests the mode when the fair market value of a property should be adopted as the current tax basis. In the event of the sale of a property, the fair market value or the purchase price will now become the revised original tax basis. Subsequently, this will now become useful for calculating the property tax for the current year and future tax periods.
Understanding the Propositions 58 and 193
While Proposition 13 insists on using the fair market value as the revised purchased price in case of a change of ownership, Proposition 58 and 193 provide an exception to this rule.
Proposition 58 and how it works
Under Proposition 58 of the California law, any intra-family property transfer between parents and their child can benefit from the tax advantage as provided under Proposition 13.
This means that the property taxes for the new owner is still calculated using the original tax basis or base year value. Intra-family property transfers do not use the current market value prevailing at the time of property acquisition.
This rule applies whether a child acquires property from his/her parents or vice versa. However, this tax benefit transfer through an intra-family property transfer deed under Proposition 58 is exercisable for up to three times only.
Proposition 193 and how it works
The working of Proposition 193 is quite similar to the working of Proposition 58. It also provides the same opportunity to forward tax benefits from one owner to another with an intra-family property transfer. However, the only difference here is that Proposition 193 deals with intra-family property transfer deeds between grandparents and grandchildren.
An example describing the collective impact of Proposition 13, 58, and 193
The following example illustrates the combined impact of Propositions 13, 58, and 193 with regards to property tax-saving benefits.
A person buys property at $100,000 and owns it for the next 20 years.
Under Proposition 13, the current tax basis used for calculating the annual property tax cannot be more than 2 percent of the base value which is $100,000. This amounts to roughly $2,000. For each of the next 20 years of their ownership, the annual increment or appreciation in property value or tax basis would not be more than $2,000. For the purpose of this example, we assume that the property underwent no capital expenditures during this entire period.
Suppose that the original owners used to pay $500 as annual property tax.
After 20 years, the owners decide to pass on their property to their heirs. This could either be their children or grandchildren.
Now suppose that at the time of intra-family property transfer deed, the current market value of the property is $1,500,000. If the applicable property tax rate is for example 1 percent, this means an annual tax liability of $15,000.
However, due to the tax benefit provided under Propositions 58 and 193, the new owners do not have to pay $15,000. The intra-family property transfer deed can exclusively transfer the property tax benefit of the previous owners to the new ones. This enables the new owners to continue paying $500 as their annual property tax instead of $15,000.
For new owners, this tax benefit remains valid as long as they continue to own the property and do not sell it.
Why hire a real estate attorney for an intra-family property transfer and dissolution deed?
Hiring a real estate attorney to formulate and structure an intra-family property transfer deed becomes necessary for many reasons. Some of these instances that require a critical review and consideration have been discussed below.
For clearing out the property title from any lien or debts
Whether a transfer of property is by gifting or selling, a person can only make such a transaction for assets and properties that he owns. But in some cases, certain properties may be subject to any debts or encumbrances. This can easily dispute the right of selling or gifting of such property until the resolution of the matter.
Probable resolutions in such matters could either be the settlement of the lien or debt, or the passing of the same to the new owner. A real estate attorney can assist in formatting and reassignment of duties to pay off the liens or debts by the new owners.
In some cases, a lien or encumbrance often remains unknown. In such circumstances, appointment of a real estate attorney can help to smooth out such issues.
Properties under mortgage
Transferring a property that is under any kind of a mortgage agreement is not allowed. Conducting such transfers goes against the “due on sale” clause which is specifically mentioned in most loan agreements. In addition to this, some mortgage agreements are inherently non-transferable.
A real estate attorney can also help in this case. Such as by –
- Suggesting ways to transfer the mortgage agreement.
- Ascertain whether the new owners qualify for the assignment of mortgage agreement or not.
- Helping the new owners obtain a fresh loan to settle the previous mortgage agreement.
Intra family property transfer in the form of a gift
A person might mention in his estate plan to appoint his/her children or grandchildren as the new owners of their property during their life or after death. This under normal circumstances is simple paperwork, involving the local recorder’s office for title transfer.
However, to make sure that the title is not subject to any sort of dispute, hiring a real estate lawyer should always be preferred.
Intra-family property transfer involving a sale transaction
Intra-family property transfers can also happen by way of a sale transaction. To do this, the children or grandchildren of the current owner (seller), could use different modes of financing.
They can either use their own money, obtain a third-party loan, or borrow funds from the seller itself.
Tax consideration involving Step-up in basis
Whether a property transfers as inheritance after the death of the owner or given away as a gift during their life, will significantly impact the amount of tax.
Gifting of properties during the life of the owner may result in the loss of massive tax advantages. However, this does not happen in the event of inheritance. The readjustment of property value by way of step-up in basis could help the heirs in minimising any applicable tax obligations.
All of this requires technical competence and advice which can only be sought from a highly experienced real estate attorney.
Although the application of Propositions 13, 58, and 193 might seem simple, it isn’t the case. To obtain maximum tax advantage and transfer of property tax benefits, consulting a real estate tax professional is the right thing to do.
Fortunately, Attorney Real Estate Group specializes in handling property tax matters and exploring the best possible options.
Simply, give us a call at 916-702-8443 or visit our website at Attorneysre.com. You can also get free legal consultation by filling in the form at this link. One of our attorneys will get back to you as quickly as possible and will be glad to assist you. We look forward to welcoming you soon.