Property Tax Change in Ownership for Estate Planners and Fiduciaries

Property Tax Change in Ownership for Estate Planners and Fiduciaries South Bay Estate Planning Council September 11, 2014 Matthew F. Burke Pillsbury Winthrop Shaw Pittman LLP 725 S. Figueroa Street Los Angeles, CA 90017-5406 Tel: (213) 488-7355 (direct) Tel: (213) 488-7100 (main) Fax: (213) 629-1033 Pillsbury Winthrop Shaw Pittman LLP

Proposition 13 Basics Beginning in 1978, fixed every property s value to the value on the 1975 lien date (plus California CPI adjustments to 1978). Capped property taxes to 1% of the full cash value, which is this 1978 established value, or the fair market value later when it changes ownership. 1978 value or value upon change in ownership = original base year value. Restricted annual increases to base year value to an inflation factor not to exceed 2% annually (set to CCPI). Original base year value factored with CCPI = adjusted base year value. Prohibited reassessment of a new base year value except upon: (a) a change in ownership or (b) completion of new construction. Prop 8 passed in November 1978 to guarantee reassessments in declining markets to the lower of fair market value or adjusted base year value. 2

Change in Ownership Three-Prong Test Revenue and Taxation Code 60 sets forth three elements that define change in ownership. A transfer of a present interest in real property (right to immediate possession, use or enjoyment; excludes transfers of future and contingent interests). Including the beneficial use thereof (right to occupy, right to income, right to transfer). The value of which is substantially equal to the value of the fee interest (protects transfers of short-term estates and leaseholds). *** A simple grant deed for a sale between unrelated parties is a change in ownership under this three-prong test. This applies to transfers of REAL PROPERTY interests. 3

Changes in Ownership RTC 61 Examples of changes in ownership transfer of real property interests: entering into, transfers of, or terminations of 35+ year leases (including options). creations, transfers or terminations of certain JTs. creations, transfers or terminations of certain TICs. vesting of a remainder or reversion (after end of life estate or other interest). vesting in beneficiary when a revocable trust becomes irrevocable. transfers between a legal entity and any other person. transfer of lifetime income interest in trust from one beneficiary to another. (RTC 61(g); Reilly v. City and County of San Francisco (2006) 142 Cal.App.4th 480; Phelps v. Orange County Assessment Appeals Board No. 1 (2010)187 Cal.App.4th 653). 4

Not Changes in Ownership - RTC 62 Exclusions from change in ownership transfer of real property to and from certain trusts. reserving an estate for years/life estate in the transferor. certain partitions of cotenancies. proportional ownership interests. perfecting title. creating, assigning, terminating or reconveying a security interest. substitution of trustee under security instrument. certain cotenancy interests under new rule in RTC 62.3. 5

Importance for Trusts and Trustees Several of the major Prop 13 cases have involved trust-owned property: Phelps v. Orange County Assessment Appeals Board No. 1 (2010) 187 Cal.App.4th 653 (plaintiff was trustee of trust that owned shopping center). Auerbach v. Assessment Appeals Board No. 1 (2006) 39 Cal.4th 153 (real party in interest was Northern Bank of California, as co-trustee of two trusts that owned Beverly Hills commercial property). Reilly v. City and County of San Francisco (2006) 142 Cal.App.4th 480 (plaintiff was trustee of trust and the sole income beneficiary). Empire Properties v. County of Los Angeles (1996) 44 Cal.App.4th 781 (involved a change in ownership of trust-owned property upon death of trustor when revocable trust became irrevocable). Allen v. Sutter (1983) 139 Cal.App.3d 887 (involved transfer by trustee of property out of the trust to the trustor s grandchildren as tenants in common). 6

Statutes on Transfers to/from Trusts The statutes include only some very basic rules covering transfers into or out of trusts. RTC 61(h) provides that included in the definition is the transfer of: Any interests in real property that vest in persons other than the trustor (or, pursuant to Section 63, his or her spouse) when a revocable trust becomes irrevocable. RTC 62(d) provides that a change in ownership does not include: Any transfer by the trustor, or by the trustor s spouse or registered domestic partner, or by both, into a trust for so long as (1) the transferor is the present beneficiary of the trust, or (2) the trust is revocable; or any transfer by a trustee of such a trust described in either clause (1) or (2) back to the trustor 7

Trust Change in Ownership See Property Tax Rule 462.160 There are two general trust transfer into/out of rules under Rule 462.160(a) and (c): Into - transfer by the trustor, or any other person, of real property into a trust is a change in ownership of such property at the time of the transfer - Rule 462.160(a). Out of - termination of a trust, or portion thereof, constitutes a change in ownership at the time of the termination of the trust - Rule 462.160(c). ** Exceptions consume the rules. 8

Exception to the Into Rule Rule 462.160(b) The following transfers INTO trusts do not result in a change in ownership: Revocable trusts Interspousal trusts Parent-child/grandparent-grandchild trusts (requirements satisfied) Proportional interest trusts Irrevocable trusts where the trustor is present beneficiary Other trusts transfers from one trust to another and meets one of these exceptions 9

Exceptions to the Out of Rule Rule 462.160(d) The following transfers OUT OF trusts do not result in a change in ownership: Revocable trusts back to the trustor Interspousal trusts Parent-child/grandparent-grandchild trusts (requirements satisfied) Proportional interest trusts Other trusts transfers from one trust to another and meets one of these exceptions ** Prior change in ownership (next slide) 10

Prior Change in Ownership Exception Rule 462.160(d)(1): There is no change in ownership if the property is being transferred out of a trust according to its terms to the person or entity who already had a present interest in the property (either use of or income from the property) while it was in the trust, either when the trust was created, when it became irrevocable, or at some other time. You do not have a second change in ownership upon distribution to the current beneficiary. No place to claim this on Preliminary Change of Ownership Report. (Use Other on Part 2, Page 2 and cite to Rule 462.160(d)(1).) Allen v. Sutter (1983) 139 Cal.App.3d 887. 11

Allen v. Sutter (1983) 139 Cal.App.3d 887 Property was transferred to an irrevocable trust for the benefit of the trustor s four grandchildren in 1961 change in ownership then. Trust provided for distributions of income for a period. In 1978, the trustee transferred the property to all four grandchildren as tenants in common in accordance with the trust terms. Court of Appeal held: the termination of the trust did not result in a change in ownership because the change in ownership already occurred in 1961; the trustee only received legal title to the property in 1961 and the trustee merely transferred legal title to the beneficiaries in 1978. The grandchildren were the beneficial owners all along. 12

Prior Change in Ownership Example 1: A transfers property to a revocable trust, for the benefit of B (unrelated), which becomes irrevocable on A s death. A dies. The change in ownership is at A s death. If the property is ultimately distributed out of the trust to B one year later, that is not a second change in ownership. Rule 462.160(d)(1) applies because B obtained the present interest when the trust became irrevocable a year earlier, on A s death. (Rule 462.260(d)(1), Example 1.) 13

Prior Change in Ownership Example 2: A transfers property into an irrevocable trust, which provides for income to C for C s life, then to D for five years, after which the property is to be distributed outright to D. The change in ownership from A to C occurs immediately. The change in ownership to D occurs on C s death. When the property is distributed to D five years after C s death, Rule 462.160(d)(1) applies. D already obtained a present interest at some other time upon C s death. 14

Beneficiaries Change During Trust Term Rule 462.160(b) -- although the exclusion from change in ownership may apply at the time of the initial transfer of property into trust, a change in ownership of trust property does occur to the extent that other persons become present beneficiaries of the trust unless otherwise excluded from change in ownership (i.e., the parentchild/grandparent-grandchild, or interspousal or registered domestic partner exclusions apply) even though there has not been a subsequent transfer of the property. The transfer of property into the trust was excluded from change in ownership. But that doesn t mean that it will always qualify for that exclusion regardless of who the trust beneficiaries are. If nonqualifying people come along and become present beneficiaries, there will be a change in ownership. 15

Beneficiaries Change During Trust Term Example: X transfers property to an irrevocable trust that provides for all of the income to X s wife Y for five years, and then after that the income is to be split evenly between Y and her sister Z. At the time X transfers the property to the trust, there is no change in ownership because the interspousal exclusion applies. However, there is a 50 percent change in ownership of the property in five years at the time Z becomes a present beneficiary. 16

Reilly v. City and County of San Francisco (2006) 142 Cal.App.4th 480 Trustor died in 1966 testamentary trust provided for net income to grandniece for life, then net income to the trustor s nephew for his life. Assessor claimed there was a change in ownership when nephew succeeded to the grandniece s income interest upon her death. Court of Appeal held: Change in ownership when a new lifetime income beneficiary succeeds another beneficiary even though the interest is only the income interest and not the right to occupy the property. Because a change in ownership occurs upon the creation of a life estate in income from real property unless an exclusion applies, it follows that the termination of such a life estate followed by the creation of a new life estate in income from the property would also qualify as a change in ownership. Are or become present beneficiaries of the trust from Rule 462.160. 17

Lifetime Right to Income is a Life Estate Concept from Reilly is crucial to trust change in ownership analysis. A lifetime right to income distributions from trust property is the equivalent of a life estate in the property just like an estate for land for life is a life estate. A life estate meets the three prongs, and therefore the life tenant is the owner for property tax purposes. When a lifetime right to income distributions terminates and a new beneficiary obtains their own lifetime right to income, there is a change in ownership. This new beneficiary has a successive life estate that is also the vesting of a remainder interest. 18

Life Estates and Estates for Years Under Reilly and Phelps, the life estate/estate for years rules apply to the income interests in trusts. Rule 462.060: The creation/transfer/termination of a life estate or estate for 35+ years is a change in ownership. The vesting of a remainder interest upon the termination of a life estate of estate for 35+ years is a change in ownership. The creation or transfer of an estate for years for less than 35 years is NOT a change in ownership. 19

Life Estates and Estates for Years Grantor of life estate Trustor Life tenant Current beneficiary Remainderman/Life tenant Successor beneficiary Remainderman Final beneficiary/distributee 20

Trust Sprinkle/Spray Provisions Rule 462.160(b)(1)(A), when a trustee has a sprinkle power to distribute trust property or income from the property to a number of potential beneficiaries, unless all of the potential beneficiaries qualify for an exclusion from change in ownership at the time of the transfer (interspousal, RDP, parent-child, grandparent-grandchild), the property is subject to change in ownership because the trustee could potentially distribute the income or property to a non-excludable beneficiary. Example 2 from Rule 462.160: Husband transfers property to trust and gives Wife, the trustee, a sprinkle power for the benefit of herself, her two children, and her nephew. Change in ownership of all property transferred to the trust, because the sprinkle power could be exercised for the benefit of nephew for whom no exclusion is available. 21

Trust Sprinkle/Spray Provisions This may also cause a change in ownership later if the sprinkle or spray power arises later even though it did not when the property was transferred into trust. Example: X transfers property to an irrevocable trust that provides for all of the income to X s wife Y for five years, and then after five years the income may be distributed to either Y or her sister Z. There is a 100 percent change in ownership of the property in five years when Z becomes a present beneficiary. 22

Per Stirpes or Equal Distributions, No Sprinkle/Spray Provisions But, a per stirpes or equal distribution will not result in a 100% reassessment, just the amount allocated to the disqualified beneficiary. Only sprinkle/spray provisions cause 100% change in ownership. Example 3 from Rule 462.160: Husband transfers property to trust with income to be distributed to Wife, their two children, and Wife s nephew in equal shares, with Wife s share remaining at her death to be distributed to their children and the nephew in equal shares. Upon Husband s transfer of the property, there is a 25% change in ownership (assuming the parent-child exclusion applies) for the 25% allocation to the nephew. Upon Wife s death, there is a 8.33% change in ownership for the 1/3 of her 25% allocated to the nephew (assuming the parent-child exclusion applies). 23

Interspousal/Registered Domestic Partner Exclusions Very broad the following interspousal/rdp transfer are not changes in ownership: Transfers in and out of trusts. Transfers that take effect on death. To current/former in connection with a property settlement agreement, decree of dissolution of marriage/partnership, or legal separation. Creation, transfer, or termination of any co-owner s interests. Distribution of a legal entity s property to a current or former in exchange for that person s interest in the entity, in connection with a property settlement agreement, decree of dissolution of marriage/partnership, or legal separation. Legal entity transfers even if change in control under RTC 64(c)(1) or change in ownership under RTC 64(d). BUT no disproportionate transfers to legal entities ** 24

Parent-Child Exclusion - RTC 63.1 Real property between parents and children (both directions). No legal entity interests. Owned by transferor no after acquired property. Unlimited principal residences. $1 million other property full cash value meaning assessed value. $1 million is per transferor separately. First properties transferred take $1 million first. Multiple properties on same day, transferees must decide. Two transferors can combine on jointly transferred property. 25

Grandparent-Grandchild Exclusion - RTC 63.1 Only transfers from grandparent to grandchild, not vice-versa. All parents who qualify as children of the grandparents must be deceased. Son- or daughter-in-law of the grandparent that is a stepparent to the grandchild need not be deceased. A probate code disclaimer does not make disclaimant deceased. Be careful with GSTs, review BOE Annotations. Exclusion only applies to the extent the deceased parent s $1 million exclusion was not fully exhausted. Principal residence may go to grandchild only if haven t received one from parents otherwise, must dip into the $1million. 26

The Transferor Concept As properties are transferred among family members, in and out of trusts, and income interests pass during the term of a trust, at issue is whether a particular exclusion from change in ownership. Whether a transfer qualifies for an available exclusion depends on the relationship between the transferor and transferee. Spouses? Registered domestic partners? Parent and child? Grandparent and grandchild? And then, do all of the requirements for the exclusion apply? 27

The Transferor Concept Do not confuse the beneficial owner with the transferor. Back to the life estate/estate for years rules. When a remainder interests vests upon the termination of a life estate, it is the original grantor of the life estate that is the transferor to the remainderman, NOT the life tenant. With trusts, the original grantor is the trustor. Life tenant/beneficiary is the beneficial owner during his or her lifetime, but is not the transferor to the remainderman. Whether an exclusion applies depends upon the relationship between the original grantor and the remainderman, NOT the life tenant and remainderman. 28 4

The Transferor Concept Example: X transfers property to his girlfriend Y, for her life, then to his son Z from a previous relationship. A change in ownership occurred, and Y is the beneficial owner of the property for property tax purposes. When Y dies, Z obtains the property. The transferor of the remainder interest to Z is his dad, X, even though Y was the beneficial owner. The parent-child exclusion applies and there is no additional change in ownership so long as all of the statutory requirements are satisfied and a claim is filed. Y was not the transferor of the remainder interest to Z, and if she had been, the transfer would not have qualified for the parent-child exclusion because Y is not Z s mother and X and Y are not married. 29

The Transferor Concept Example: M transfers property to her son N, for his life, then to N s daughter O, for her life. M has created a life estate in N, followed by a life estate/remainder interest in O. When N dies, the transfer to O is from O s grandmother, M. The parent-child exclusion does not apply because the transfer is not from N to O. The grandparent-grandchild exclusion may apply if all of the requirements of RTC 63.1(a)(3) are satisfied (principally that N did not fully exhaust his $1 million exclusion, and that O s mother be deceased at the time of N s death). 30

The Transferor Concept The transferor concept applies equally in trusts. The trustor is the transferor of the lifetime income interest to any successive income beneficiary. Determining whether an exclusion applies depends upon the relationship between the trustor and the new beneficiary, not the relationship between the prior beneficiary and the new beneficiary. This is particularly important when allocation the $1 million parentchild exclusion amounts. Exception: general power of appointment. 31

Legal Entity Interest Transfers Principal rule is RTC 64(a) -- transfers of interests in a legal entity do not result in the transfer of the entity s real property. There are two principal exceptions: If there is a change in majority ownership or control of the entity under RTC 64(c)(1). If there is a change in ownership of the entity under RTC 64(d). 32

Legal Entities - Change in Majority Ownership or Control RTC 64(c)(1) Occurs when a single person or entity obtains: direct or indirect ownership or control of more than 50% of a corporation s voting stock. direct or indirect ownership of more than 50% of the total interest in capital and profits in any partnership or LLC. Result: a 100% reassessment of all real property owned by the entity (including certain leaseholds and reversionary interests). Unlimited statute of limitations if not reported. 33

Change in Control Rule 462.180, Example 7 Spouses H and W acquire as community property from the current owners, who are not original co-owners, 100% of the capital and profits interests in an LLC which owns Blackacre. Each of H and W is treated as acquiring 50 percent of the ownership interests as defined in subdivision (c) and Revenue and Taxation Code Section 64(a). No change in control of the LLC; no change in ownership of Blackacre. 34

Ocean Avenue LLC v. County of Los Angeles 227 Cal.App.4th 344 (2014) Case involved Fairmont Miramar Hotel in Santa Monica. Originally structured as a sale of the fee interest to a Michael Dell-owned entity. After down payment paid, they canceled the deal and renegotiated a new structure. Instead, buyers had multiple parties buy all the interests in Ocean Avenue LLC, the entity that owns the Hotel. Dell split it with his wife and some financial advisors. No one got more than 50% capital and profits individually. No spousal attribution in California (Example 7). Assessor reassessed, claiming a change in ownership. Taxpayer lost at AAB, appealed to superior court and won. 35

Ocean Avenue LLC v. County of Los Angeles County appealed the case to the Court of Appeal. Decided June 3, 2014. Court of Appeal affirmed ruling for taxpayer. No change in ownership when no single person obtains more than 50% of the capital and profits interests in an entity. Court rejected all of the County s equity arguments (substance over form, equitable conversion), and rejected notion that just because 100% of an entity transfers, there must be a change in ownership. Under the statutes, there isn t. Court rejected the application of the three-prong test to legal entity interests. No change in ownership of the Hotel. 36

Legal Entity Change in Ownership (Original Co-Owner Rule) Change in ownership occurs: Cumulatively > 50% of the entity interests have been transferred by the original co-owners. When are entity owners are original co-owners? Property was transferred to the entity using the proportional ownership interest transfer exclusion. Property reassessed just that transferred to the entity. Unlimited statute of limitations if not reported. 37

Legal Entity Change in Ownership (Original Co-Owner Rule) Transfers to children and grandchildren must be counted. Transfers to spouses and RDPs need not be counted. Once an interest has been counted toward the 50+%, the transferee is not an original co-owner. If the transfer is not counted (i.e., to spouse or RDP), the transferee is an original co-owner. Must identify for each entity whether the owners are original coowners or not. Must identify how many interests have been transferred. 38

Trustee Filing Requirements Parent-child exclusion claim form: the trustee can sign the claim form as trustee of transferor s trust, or trustee as transferee s trust (RTC 63.1(d)). If have change in ownership during trust term without transfer of property (new income beneficiary as in Reilly), trustee must file the requisite change in ownership statement with the county recorder within 150 days after date of death (RTC 480). Legal entity change in control/ownership: Form BOE-100-B must be filed with BOE within 90 days of date of change in control/ownership, or face automatic 10% penalty (RTC 480.1, 480.2). 39

Statutes of Limitations for Escape Assessments Legal entity change in control/ownership: if fail to timely file Form BOE-100-B, unlimited statute of limitations. Changes in ownership on non-legal entity transactions (i.e., deed transfers or other changes in ownership reportable to the county): Generally 4 years statute of limitations if recorded. 8 years if fraud penalty is applied. 8 years if unrecorded change in ownership meaning a deed or other document evidencing a change in ownership was not filed with the recorder at the time the event took place. 40

Statutes of Limitations for Escape Assessments Examples of Statutes of Limitations: Change in control of legal entity in 1983 Change in control of legal entity in 2001 Property held in trust changed income beneficiaries in 1994, 2000, and 2008 Disproportionate deed transfer to legal entity in 1995, but claimed proportional exclusion and recorded deed and filed PCOR, followed by transfer of >50% of original co-owner interests 41