By Nelson J. Handy, Esq., CPA

I. Proposition 13

A. Prior to the passage of Proposition 13 in 1978, California's property tax system was based on current valuations, and the rate of tax was not fixed.

B. After passage, Proposition 13 became Article XIIIA of the California Constitution.

1. Proposition 13 limited the ad valorem tax on real property to 1% of the total cash value and limited subsequent increases in that value to 2% per year.

2. The tax is applied to acquisition value, subject to certain modifications.

3. Proposition 13 provided that after any change in ownership, the assessor was to re-value the full cash value to the current fair market value of the property.

a. New construction results in partial reassessment.

4. Since its passage, a property tax system under Proposition 13 has been clarified and refined by various court decisions and legislative acts and still remains ambiguous on many provisions.

II. Statutes Regarding Change in Ownership

A. The statutes regarding changes in ownership are set forth in California Revenue and Taxation Code Sections 60 through 66. (All references herein are to the Revenue and Taxation Code.)

B. Section 60. A "change in ownership" means a transfer of a present interest in real property, including the beneficial use thereof, the value of which is substantially equal to the value of the fee interest.

C. Section 61. Examples of Specific Inclusions

1. The creation or transfer of leasehold interests for more than 35 years (Section 61(c)(1));

2. The creation, transfer, or termination of a joint tenancy, except as otherwise provided (Section 61(e));

3. The creation, transfer, or termination of a tenancy in common, except as otherwise provided (Section 61(f));

4. The transfer of any interest in real property between a corporation, partnership, or other legal entity and a shareholder, partner, or any other person, except as otherwise provided (Section 61(j)).

D. Section 62. Examples of Specific Exclusions
1. "Any transfer between an individual or individuals and a legal entity or between legal entities, such as a cotenancy to a partnership, a partnership to a corporation, or a trust to a cotenancy, that results solely in a change in the method of holding title to the real property and in which proportional ownership interests of the transferors and transferees, whether represented by stock, partnership interest, or otherwise, in each and every piece of real property transferred, remain the same after the transfer." (Section 62(a)(2))
a. This is a specific exclusion for transfers between legal entities and individuals. For this exception to apply, the ownership interests must be exactly the same. There is no de minimis exception for small changes in ownership interests.

2. Creation, assignment, or termination of security interests (Section 62(c)(1)).

3. Any transfer in trust (Section 62(d)), if any of the following apply:

a. Trustor or spouse is the present beneficiary;
b. Trust is revocable;
c. Reverse of (a) and (b); or
d. Trustor retains reversion which will occur in less than 12 years.

4. Creation of estate for life or years for the transferor (Section 62(e)). Change in ownership occurs at end of the term.

5. Creation of joint tenancy if the transferor remains as one of the joint tenants (Section 62(f)).

6. Any transfer of real property which is subject to a lease with a remaining term of over 35 years (Section 62(g)).

E. Section 63. Interspousal Transfers--Section 63 provides as follows:

"Notwithstanding any other provision in this chapter, a change in ownership shall not include any interspousal transfer, including, but not limited to:

(a) Transfers to a trustee for the beneficial use of a spouse, or the surviving spouse of a deceased transferor, or by a trustee of such a trust to the spouse of the trustor,

(b) Transfers which take effect upon the death of a spouse,

(c) Transfers to a spouse or former spouse in connection with a property settlement agreement or decree of dissolution of a marriage or legal separation, or

(d) The creation, transfer, or termination, solely between spouses, of any coowner's interest.

(e) The distribution of a legal entity's property to a spouse or former spouse in exchange for the interest of such spouse in the legal entity in connection with a property settlement agreement or a decree of dissolution of a marriage or legal separation."

F. Section 63.1. Parent-Child Exclusion; Proposition 58
1. Applies to transfers from parents to children and from children to parents (Section 63.1(c)(1)).

2. Exclusion for transfers of a residence are not limited by a dollar amount (Section 63.1(a)(1)).

3. Exclusion for property other than residence is limited to lifetime transfers of $1,000,000 based on "full cash value" (Section 63.1(a)(2)).

a. Full cash value, for purposes of the parent-child exclusion, is defined in Section 110.1 (Section 63.1(c)(5)). Simplified definition of full cash value for parent-child exemption is the trended Proposition 13 value.

4. As of March 27, 1996, grandchild can take place of deceased child. But all "children" who are the grandchild's parent must be deceased. The son- or daughter-in-law who was married to the deceased child is considered an eligible child until remarriage (Section 63.1(c)(2)).

5. Transfers under this section are changes in ownership until the filing of a claim for exclusion.

a. Claim must be filed within three years of transfer.
(1) Exception -- six-month grace period after issuance of Notice of Supplemental Assessment or Notice of Escape Assessment (Section 63.1(e)(1)(C)).

b. Transfers in trust present special problems.
(1) Empire Properties. For trusts that become irrevocable on death, date of death is transfer date.

(2) Leckie. Creation of a life estate in a non-spouse is a change in ownership. But what about the transfer to children after intervening life estate? Commentators have gone both ways on whether the parent-child exclusion applies.

(3) Mixing of exceptions and exclusions (such as spousal and parent-child) may be hard to apply. (Example: transfer to a credit shelter trust that has spouse and children as current beneficiaries; file that protective claim!).

G. Section 64. Transfers of Interests in Legal Entities
1. General Rule--Transfers of interests in legal entities do not result in a change in ownership for the property held by the legal entity (Section 64(a)).

2. Exceptions

a. Section 64(c). Whenever there is a change in control of a legal entity by an owner attaining more than 50% of the voting interests, there is a change in ownership of all property owned by the legal entity.

b. Section 64(d). Transfer by original owners of entity of more than 50% of ownership of entity results in reassessment of property transferred into an entity in transaction that was not a change in ownership ("tainted property").

(1) See exemption above for transfers to or from legal entities that do not change proportional interests.

(2) However, if partners contribute cash, and partnership purchases property, the later transfer of over 50% of partnership (which does not result in a change in control) does not trigger reassessment of those properties.

(3) Regulations resolved that mergers of partnerships into limited liability companies are not transfers of property if law provides that entity remains same entity. Therefore, no tainted property resulted from the merger.

H. Section 65. Joint Tenancy Property
1. Creation or transfers of a partial interest in joint tenancy property when transferor remains as one of the joint tenants is not a change in ownership (Section 65(b)).

2. Transfers of joint tenancy interests described in Section 65(b) are reassessed if original transferor no longer has an interest in the property (dies or transfers his interest) (Section 65(c)). But note that spouse of original transferor can become original transferor.

I. Section 65.1. Changes of ownership only apply to portions of properties transferred. De minimis exception for portions worth less than $10,000 which are less 5% of the total property.

J. See also change of ownership regulations in California Code of Regulations Title 18, Chapter 4, Article 4 (Sections 460 et. seq.).

A. Empire Properties v. County of Los Angeles (44 Cal. App 4th 781 (Second Appellate District 1996)). In this case, the court determined the date at which a change in ownership occurred for purposes of determining the three-year deadline for filing the parent-child claim for exclusion from reassessment. The trustor of a revocable trust died in October 1987. In November 1991 transfers were made from the decedent's trust to his daughters. Additionally, in November 1991, the children filed the claim for a parent-child exclusion. The court determined that the date of the actual transfer of the property was irrelevant and that the transfer date was the date the daughters' interest in the property vested. The daughters' interest in the property vested when the transferor died and his trust became irrevocable.

The Empire Properties case forces the practitioner to focus on the date of vesting rather than the date property is transferred to a beneficiary. This is of particular significance in the case of a transfer to a trust for which a child is a vested beneficiary along with the spouse of the transferor. Should the practitioner file a parent-child exclusion upon the death of the first spouse to die? Should the practitioner file the parent-child exclusion upon the death of the second spouse (the time of vesting of the remainder interest in the beneficiary)? Should a practitioner file a parent-child exclusion at both times?

B. Bernard A. Leckie v. County of Orange (65 Cal. App 4th 334 (Fourth Appellate District 1998)). In this case, the transferor granted a life estate to his girlfriend and a remainder interest to his children. The court determined that there was a change in ownership upon creation of the life estate. The question that remains is what happens to the assessment upon termination of the life estate and transfer to the children. One commentator, in interpreting the court's language, believes that parent-child exclusion cannot bring the assessment back to the father's assessed value upon death of the life tenant. The critical language in the case is as follows:

Leckie also points to the statutory exemption to reassessment for a principal residence transferred between parents and children (Section 63.1) and claims the policy behind this exemption will be defeated by reassessing the property at a higher value upon the transfer of the life estate. Had the intervening transfer of the life estate been an "economically or legally meaningless transaction" Penner v. County of Santa Barbara (1995) 37 Cal. App. 4th 1672, 1679 [44 Cal. Rptr. 2d 606]), Leckie might prevail under the step transaction doctrine, which focuses on the end result of a series of transfers. (Ibid.) But Cordova's life estate is a significant deviation from the path to the transfer of the fee to the children. Reassessment here does not violate the spirit of section 63.1.

However, another commentator, relying on the State Board Letters to Assessors, believes that the parent-child exclusion can be saved. The relevant State Board Letter provides:
Question: A mother died. In her will she granted a life estate in real property to a friend with the remainder to her children. Should the parent-child claim be filed upon the death of the mother or the termination of the life estate?

Answer: A reappraisable change in ownership occurred when the life estate was created because it vested in a person other than the transferor or the transferor's spouse. Similarly, a change in ownership occurs when the life estate terminates and the property passes to the remainder person. However, upon the termination of the life estate, the remainderman rights of the children become possessory. The filing period for the parent-child exclusion begins to run when their interest becomes possessory–upon the termination of the life estate. Assuming the parent-child claim is timely filed, the property will retain the base year value determined when the life estate was created.

State Board letter to Assessors dated April 22, 1998, Question and Answer No. 22.

C. Shuwa Investment Corp. v. County of Los Angeles (1 Cal. App 4th 1635 (Second Appellate District 1991)). In Shuwa, the downtown Los Angeles Arco Plaza was owned by partner A and partner B. Shuwa was interested in purchasing the property. For various reasons, the transaction was structured in three steps. The first step was that A sold its partnership interest to Shuwa. The second step was that B and Shuwa dissolved the partnership and each received a 50% undivided interest in the property. The third step was that B sold its undivided 50% interest in the property to Shuwa.

Taken as separate transactions, the first two result in no reassessment, and the third transaction only results in reassessment of 50% of the property.

The court determined that under the "end result test," three steps were part of a single transaction intended to transfer 100% of the property to Shuwa. Additionally, the "interdependence test" was satisfied as all of the parties would not have agreed to the transaction if all of the steps did not take place. Additionally, the "binding commitment test" was met because the parties were bound by a single contract to take all three steps. Further, no legitimate business purposes were identified to justify all of the steps.

The court also cited a uniform standard adopted by Los Angeles for determining when a step transaction will occur which states:

Where a taxpayer utilizes a series of transfers or steps to effect a transfer which might otherwise have been accomplished by fewer transfers or steps, we recommend that any steps in the transaction be disregarded if the county assessor concludes that they are not supported by a business purpose other than avoiding higher property taxes.

A later court of appeals case applied the step transaction doctrine and affirmed the reassessment of property in a case wherein only the interdependence test was proven by the assessor (McMillin, 31 Cal. App. 4th 545).

D. Joyce E. Penner v. County of Santa Barbara (37 Cal. App. 4th 1672 (Second Appellate District 1995)). In Penner, the court decided the issue of whether the parent-child exclusion from reassessment would apply to transfers of interest in entities holding real property. Penner is also important for a second reason, that is, applying the step transaction doctrine to transfers of interests in entities.

The facts are critical in Penner. Although not completely clear, the court indicated that the parent was the sole original limited partner and the parent's son Steven was the sole general partner. Upon contribution of her property to the partnership, the parent then transferred four small additional limited partnership interests to her children. It is important to note that this transaction from the start does not fall into the exception for changes in ownership as the result of proportional interests being held by all the parties before and after the transaction. Before the transaction, the son owned no interest in the real property and after the transaction he had a small interest in the property. Accordingly, as a result of the transaction, the real property was immediately subject to reassessment.

The parent and children then applied for the parent-child exclusion from reassessment. The court, after extensive argument regarding the step transaction, focused on the actual application of the parent-child exclusion and stated, "It is relatively simple to determine whether a transfer will qualify for the parent-child exemption. Property must be transferred from one natural person to another. One of those persons must be a parent, and the other must be [a child]."

Since the Penner case came out, there has been no further controversy regarding the inability to apply the parent-child exclusion to interests in real property held by an entity. However, some of the county assessors have focused on the analysis of the step transaction doctrine in Penner and have taken the case to an unjustified level.

Many county assessors are determining that when a family limited partnership is created and the formation of that partnership does not result in reassessment because all of the parties retained proportional interests in the property before and after, the subsequent transfer of an interest in that partnership to a child completes a step transaction which must result in reassessment of the real property. The assessors have taken the position that if they can reconfigure the transaction so that a reassessment could occur, then the transaction could be cast in that manner and the reassessment made. I expect at some point a court will address this issue but until then, it is advisable to put as much time as possible between the formation of the partnership and the transfer of the limited partnership interests to children.

E. Munkdale v. Giannini as County Assessor (35 Cal. App 4th 1104 (First Appellate District 1995)). In Munkdale, two brothers held 11 parcels of property in a partnership. The brothers decided to dissolve the partnership, and they distributed to each partner equal value in properties, but all but one property was distributed to one partner or the other. The court determined that reassessment was proper and that reassessment should apply to 100% of each divided property. The brothers argued that since they were proportional 50% owners of each property prior to the distribution of the partnership property, they should only be reassessed 50% of each property. The court rejected that argument in determining that 100% of the properties was to be reassessed.

The court also mentioned that the one property that was transferred to each of them as tenants in common was not reassessed.

A. Creation and funding of living trust

B. Administration of a trust on death of a settlor

C. Creation of an entity

D. Creation of an entity for estate planning purposes

E. Dissolution or liquidation of an entity

Harry and Wilma are husband and wife. Among Harry and Wilma's assets are a residence worth $500,000, a vacation home worth $300,000, and an apartment building worth $1,000,000. On January 1, 1998, Harry and Wilma create the H & W Revocable Trust. They name themselves as trustees of the trust and transfer title to the three parcels of real property to themselves, as trustees of the H & W Revocable Trust.

Question No.1: Has a change in ownership occurred as defined in the Revenue and Taxation Code?

Answer. No. Pursuant to Section 62(d), transfers to a revocable trust and transfers to a trust for the present benefit of the trustor are not changes in ownership.

Answer. No. Identity of the trustee is not a factor in Section 62(d).

Answer. No, because the trust is still revocable.

Case Study No. 2: Death of a Settlor

Assume the creation of a trust as described in Case Study No. 1.

Question No. 1: What steps should be taken to transfer a parcel of property to a Bypass Trust on the death of Harry?

Answer. At a minimum, a deed to the Bypass Trust should be recorded. The recording of a deed should be accompanied by a Preliminary Change of Ownership Report (PCOR). Filing an affidavit of death of trustee is recommended. Whenever a person dies owning any interest in real property, a Change in Ownership Statement (Death of Real Property Owner) is required to be filed with the county assessor.

Answer. A Change in Ownership Statement (Death of Real Property Owner) is required (assuming the real estate was community property). It is recommended that a deed to the Survivor's Trust, a PCOR, and an Affidavit-Death of Trustee also be filed so that trust administration is kept orderly.

Answer. The filing of a Claim for Reassessment Exclusion For Transfer Between Parent and Child will avoid unnecessary reassessments. See Empire Properties case.

Abby, Betty, Carla, and Denise form XYZ Corporation as 25% owners each.

Question No. 1: If they each transfer to XYZ Corporation a parcel of real property worth $100,000 (each person transfers a separate property), has a change in ownership occurred?

Answer. Yes, this does not qualify as a transfer without changing the proportional interests of the co-owners (Section 62(a)), as each owner went from a 100% owner before transfer to a 25% beneficial owner of each property after the transfer.

Answer. No, this qualifies as a transfer between individuals and a legal entity where the proportional interests remain the same after the transfer (Section 62(a)(2)).

Answer. Yes, there has been a change in ownership as to 25%. Where only a portion of the real property is transferred, only the portion transferred is reappraised (Section 65.1(a)).

Answer. If 50% of the stock is sold, there is no change in ownership because more than 50% of the interest in an entity must be transferred by the original co-owners to trigger a change in ownership pursuant to Section 64 (d) (assuming that the property was originally contributed by the stockholders). Additionally, no change in ownership will have occurred as a result of a change in control pursuant to Section 64(c) as Fran has not acquired over 50%. But if Abby were to purchase 50%, combined with her existing 25%, she will have exceeded 50%, and a change in control and a change in ownership pursuant to Section 64(c) will have resulted.

Case Study No. 4: Creation of an Entity For Estate Planning Purposes

Harry and Wilma intend to create a family limited partnership. They intend to ultimately transfer the property to their son, Sam, and daughter, Dana.

Question No. 1: If they create and fund the partnership and subsequently transfer 25% ownership interests in the partnership to each of Sam and Dana, has a change in ownership occurred at any stage in this transaction?

Answer. No change in ownership occurred on creation of the partnership (see Case Study No. 3). On transfer of 25% each to Sam and Dana, total transfers will be 50%, and the threshold for change in ownership (more than 50%) will not yet have been reached (Section 64(c) and (d)). However, note that some assessors are applying the step transaction doctrine. No case yet on point, but see Shuwa Investment Corp. and Penner for background on application of step transaction doctrine to property tax cases. Have any of the three tests identified in Shuwa been satisfied?

Question No. 2: If Harry and Wilma instead first transfer 25% of the apartment building to each of Sam and Dana and then Harry, Wilma, Sam, and Dana each transferred their interests into the partnership, has a change in ownership occurred?

Answer. Upon transfer of property to a child, a change in ownership occurs. There is the option of filing a Claim for Reassessment Exclusion based on a parent-child transfer, limited to $1,000,000 for each transferor (parent). Upon subsequent creation of the partnership, no change in ownership has occurred (see Case Study No. 3).

Answer. No. See Penner v. Santa Barbara. Claims for exclusion from reassessment for transfers between a parent and child do not apply to transfers of legal entities between a parent and child.

Case Study No. 5: Dissolution or Liquidation of an Entity

Assume a partnership with two partners is liquidating. The partnership, before liquidation, owns three parcels of real property, A, B, and C, each worth $500,000. The partners are Paul and Pat, who each own a 50% interest in the partnership.

Question No. 1: If, upon dissolution of the partnership, Paul and Pat each receives a one-half tenants-in-common interest in A, B, and C, has a change in ownership occurred?

Answer. No, as this is a transfer between an entity and individuals where the proportional interests of the parties remain the same after the transfer (Section 62(a)).

Answer. Yes. There has been a change in ownership, and there will be a full reappraisal of Parcels A and C as the proportional interests in these properties are not the same after the transfer. Parcel B has not had a change in ownership as the proportional interests of the parties in this property remain the same after the transfer (Section 62(a) and see Munkdale v. Giannini).

Answer. Yes. There has been a change in ownership of 50% of parcels A and C, as this is a transfer of a partial interest in a property (Section 65.1). However, could the assessor argue under Shuwa that the interim step only had a tax avoidance purpose?

IV. Procedures--Appealing Assessments

A. Appeals Process
1. Informal Appeal
a. File request directly with Assessor

b. Deadline for filing informal appeal is set by the Assessor

c. Assessor is not bound to act on the informal appeal

2. Formal Appeal
a. Appeal to be filed with the County Assessment Appeals Board

b. Date for filing appeal is between July 1 and September 15 of the year for which the appeal is being filed

(1) Property tax year is July 1 to June 30
(2) Valuation date (lien date also) is January 1 (six months before applicable property tax year)

c. Appeals Board requests the Assessor to submit their determination of value

d. Conference with Assessor may resolve determination of value

(1) Assessor can (but probably will not) change the valuation without approval of Appeals Board
(2) Agreed-upon valuation can be presented to the Appeals Board for approval, which approval is usually given

e. If no agreement with Assessor, then present evidence of value before the Assessment Appeals Board

f. Assessment Appeals Board will not decide on issues of law

B. Valuation of Property
1. Methods of Valuation
a. Income Method
(1) Capitalizing income for a typical year or determining present value of a stream of income
(a) Discount and capitalization rates need to be justified
(b) Evidence of a typical year of income or justification for use of estimated future income streams should be presented

(2) Income method most relevant to income producing property with a track record of producing income (example: hotels and office buildings)

b. Comparable Sales
(1) Comparison of recent sales that are similar to subject property
(a) Property should be close in proximity, size, condition, etc.
(b) It is critical to reconcile differences between the subject property and the comparison property and to assign negative or positive values to those differences

(2) Comparable sales are most applicable to non-income producing properties (residences, vacant land, and new construction)

c. Replacement Cost
(1) Show the cost of acquiring similar land and building a similar structure
(2) Most applicable to new construction
(3) Harder to apply for older structures because of depreciation and obsolescence

C. Statutes of Limitation
1. Claiming a refund
a. For Proposition 8 (temporary reduction) or appeal of base year value, limited to a refund for year in which appeal was taken (Section 80(a)(5))
(1) Claim must be filed between July 1 and September 15 of affected year for any assessment made within the normal assessment period
(2) For assessments not made in the normal assessment period, claim must be filed within 60 days of mailing any assessment made outside of the normal assessment period
(a) Examples: new assessments and escape assessment

2. Reduction in base assessment
a. Can be filed up to three years after year in which the base year assessment is placed on the assessment roles (Section 80(a)(3)) - but note, refund only given for the current year