A possible legal strategy remains open for people to pass their Prop 13 tax assessment caps to their children now that the Prop 19, Feb. 16 2021 deadline has passed. The “Family Property LLC” concept is complex, but should be considered, especially by high-net-worth families.
By James L. Cunningham Jr., Esq.
(This is an update to an earlier blog at this location which described how to transfer a property to a child before Prop 19 went into effect on Feb. 16, 2021. That legal strategy, which included an irrevocable “Proposition 13 Trust” is no longer available, and should not be pursued. This article proposes an entirely new strategy, now that Prop 19 has gone into effect.)
Now that the California Prop 19 deadline has passed, is there any way you can still transfer your low Prop 13 tax assessment caps to your children? The answer is maybe. My office believes that one legal path remains, though it is a tad winding and complex.
After the 2020 election, my office received literally hundreds of calls a week from people scrambling to transfer homes and other properties to their kids before the Feb. 16, 2021 deadline, when the new law went into effect. These families saw a direct threat to their lifetime effort to create stable economic lives for their children and their children’s children. My office had the capacity to help only a fraction of those inquiring during the short window between the election and the deadline.
Now our team of lawyers is looking for new legal pathways for inherited properties—as well as techniques to avoid expected new estate taxes and tax increases overall. These pathways often include the creation of what we’re calling a “Family Property LLC.”
Let me say up front that this path may not be appropriate for your family. For example, your children may simply want to sell all your real estate when you pass. If that’s the case then saving your Proposition 13 tax base for your children may not be important. Depending on your particular circumstances, you may trigger a variety of other consequences down the road which MUST be discussed with a highly-knowledgeable lawyer before you take action. I encourage to contact CunninghamLegal to work on these complex issues with you.
Devastating Impact of CA Prop 19
Let’s be clear that the effect of Prop 19 will be devastating to many families of all income levels, but especially the lower half of incomes. At least 700,000 families across the state face the loss of their Prop 13 inheritance rights. Some who called us were literally in tears, and we’re not just talking about high-net-worth families. We’re talking about plenty of blue-collar folks who managed to buy a house years ago, but realized they could no longer leave that house to their kids without also leaving them huge new property tax bills.
If you bought a California house in the 1990s for a few hundred thousand, that house may now be worth a million or two. If it gets reassessed when your kids inherit, they could be facing property taxes of $30,000, $50,000, $70,000 or more a year. The result? In a few decades, only wealthy people who can pay those kinds of taxes will be able to hold on to real estate. Others will likely be forced to sell.
Prop 19 does make a narrow exception for primary residences transferred only to your child, during your lifetime or after your death—but then your child must themselves live on the property as the owner. If that’s not enough, if the home is worth more than $1M, the home may be partially or entirely reassessed! The result? A partial or complete loss of your Proposition 13 tax benefit. Read our practice page on Prop 13 to learn more about these changes.
In most cases, this will effectively eliminate the ability of a parent to leave a low tax assessment to a child. Why? Because very few people who inherit their parents’ home will actually want to live in that home—and many homes are worth far more than $1M in California.
All this made Proposition 19 a huge departure from previous California law. In the most underreported story of the election, Prop 19 brought catastrophic change for taxpayers who own California real estate and have kids: before Prop 19, under Prop 58 parents could pass Prop 13 tax caps on their children for nearly any kind of property.
Did People Know What They Voted for in Prop 19?
I suspect that few people who voted for Prop 19 realized the way the law would destroy inheritance rights. Why? Because Prop 19 was complex, and it was cleverly worded in a way that put a far more acceptable issue up front. Most people happily voted to expand the ability of people over 55 to transfer their tax caps to another property during their lifetimes, and many people probably did not read the second, far more important provision in the initiative related to inheritance rights.
It’s possible Prop 19 will be challenged on the basis that it covered two entirely different issues, thus confusing voters. But as of this writing, it has gone into effect.
Now What? The LLC Path for Post-Prop 19 Transfers
At CunninghamLegal we believe at least one possible strategy remains for people to beat Prop 19 and still transfer or pass on their Prop 13 tax caps when they die.
This strategy is fairly complex, and it won’t be for everyone. It requires working with a skilled lawyer over a goodly number of years because of the nature of the strategy.
For those with the means and the will to pursue significant transfers of multi-generational wealth, we believe the strategy offers a viable path. Every day, we work with savvy, caring high-net-worth families undertaking generational tax-planning—and we are beginning to work this tactic into overall wealth transfer efforts. As we learn more, we will continue to update this article.
Family Property LLCs to Preserve Prop 13 Tax Caps
The “Family Property LLC” strategy requires a skilled and knowledgeable lawyer to implement, but anyone with a business background should be able to grasp the concept.
Remember that under Prop 19, most properties will now be reassessed when transferred to a child, whether before or after your death—with the consequent enormous increase in property taxes. This is known as a Change in Ownership under California Revenue and Taxation Code Section 60. But a government assessor, as well as any good lawyer, will ask, “What in California constitutes a ‘transfer’ or a “change in ownership” and how much of a transfer triggers a reassessment?”
Under present California law, whether a property is reassessed when a Change in Ownership occurs hinges on a broad set of facts. One exception is when 50% or less of the ownership interest in an entity such as an LLC, Partnership or Corporation changes hands, then in most cases there is no reassessment provided no one person ends up with more than 50% ownership or ends up with control. If more than 50% gets transferred, generally the whole property gets reassessed.
The entire process is simpler if the LLC is the original owner of the property, in which case more than 50% can pass, so long as no one person gets more than 50% or control. But we won’t further detail that scenario here.
How to Transfer Property at 50% or Below Ownership
Now, a creative lawyer will ask the question, “How can a property move forward through generations without 51% ever being transferred from one person to the next or from multiple parties to multiple parties?”
We know that trusts, whether revocable or irrevocable, will not work for this purpose. Why? Because when it comes to taxation, the Board of Equalization and the Assessor’s office disregard trusts – they treat them as transparent. For our purpose, we will need to turn to another ownership and control vehicle: the Limited Liability Company, or LLC.
Let’s say that you (or you and your spouse as joint tenants) own an apartment building, and you have two children, David and Julia. You want to transfer your apartment building equally to David and Julia in such a way that the property is never reassessed – not when you do the transfer, not when they die, and not when they pass the property on to their children.
Here’s how a new form of transfer may be possible, even after Prop 19.
- You form a new Limited Liability Company we’ll call “LLC1.” You decide to create a Family Property LLC to train David how to manage properties. You move the apartment building into LLC1, and you give 50% of the shares to David. Because David received 50% ownership, no “transfer” occurred, and the property is not reassessed. You don’t include both David and Julia in LLC1 at 50% each, because the total transfer would equal more than 50%.
- Now, you train David on how to manage the apartment building over the next year or so. You wait because you want to see how it goes being partners with David and you need to avoid any possible issue with the “Step-Transaction Doctrine” that might compress all your moves into one “step” under the law. (While it’s true that the Doctrine does not currently apply to intra-family actions, that law will likely change due to Prop 19). PS, don’t die during that year, or David may inherit all or part of your share, and the total transfer will exceed 50% with a consequent reassessment.
- A year later, you decide that managing the properties with David wasn’t such a good idea, so you dissolve LLC1, with 50% of its assets (the property) going to you and 50% going to David. You need to do this to enable the next step.
- Then you wait another year while holding the property as tenants in common with David 50/50.
- Now you and David form LLC2 to hold the property, after which you give your 50% of the shares in LLC2 to Julia, who has been waiting patiently all this time. Now David and Julia own the property and manage it together.
- If you have more than two children, you will need to repeat the process until everyone gets their cut—and no transfer exceeds 50%.
- When Julia and David have kids, they will want to dissolve LLC2 and temporarily take their halves under their own ownership.
- Then they can form LLC3 and repeat the process for the next generation.
If you do this correctly, the property will never be reassessed. And you can even stay on as manager of the LLC while you are alive. Successor managers can manage the LLC similarly to the way a trustee manages a trust.
Daisy-Chained Property Inheritance LLCs
As you can see, this LLC creation and dissolution process can be daisy-chained right through the generations.
Importantly, any time one of the players dies, the situation must be carefully re-thought with LLC share transfers, creation and dissolution engineered so as never to transfer more than 50%. If at any time a transfer goes over 50%, the effort ends, and the property gets reassessed—so the process must be deployed with skill. So, people must die on time and in order. Unfortunately, people often die out of order and not on time.
If the value of your properties (and potential property taxes!) are high, the costs of this strategy in legal and LLC fees might well make sense for your family. It’s difficult to estimate the legal costs at this time, as situations will vary so much.
If you have only one child, or need to exclude a child from this arrangement for one reason or another, you and your lawyer will likely have to get creative to find another LLC owner to involve, so you can create the proper daisy chain of ownership–such as including a charity in the LLC, and then later cancelling that donation.
In addition, the order of deaths within a family must be “planned” along with the LLC chain, or the entire chain might also fall apart – hence the long-term commitment to working with a good law firm which stays on top of the situation.
Yes, it’s certainly possible that the Assessor’s office will challenge the validity of your arrangements and attempt a reassessment, requiring appeals. So yes, the family must have both the resources and a certain fortitude of will to pursue this route. If done properly, the chances of reversing an adverse ruling by the Assessor are high.
A Family Property LLC Could Potentially Avoid New Estate Taxes
It is expected that the Biden Administration will greatly lower the threshold for estate taxes (the Death Tax). It’s also likely that Biden will attempt to eliminate the Step-Up Basis for investment values at death, along with other coming changes in taxation requiring urgent planning. A similar Family Property LLC technique could possibly allow your family to escape the consequences of those changes as well, through the careful management of multiple assets through your death.
As wealthy families have long known, it’s often wise to have an LLC own your assets—while you continue to exercise control. But general estate taxes are a subject beyond the scope of this article.
A Long-Term Wealth Transfer Strategy with a Law Firm
Does a Family Property LLC strategy require a good law firm, with which your family will engage over years, even decades, one generation to another? You bet. Can mistakes along this path lead to major negative financial consequences? Certainly. But the new tax laws will lead to major consequences as well.
Advanced Tax Planning Consultation at CunninghamLegal
In the shadow of the many significant tax changes occurring both nationally and statewide, I urge you to step back to take stock of your family’s challenges and opportunities. I also urge you to consult with a qualified attorney and tax planning specialist, not just a bookkeeper or CPA, about your options.
You can book a consultation with CunninghamLegal using the form on this page, by calling us at +1 866.988.3956, or by clicking here.
Follow this Page & Our YouTube Channel for Updates
We will be posting updates to our Post-Prop 19 strategy recommendations on this page as they develop. We also invite you to subscribe to our YouTube channel, where we follow these issues closely.
What Do We Do as California Estate Planning Attorney Specialists?
The lawyers and staff at CunninghamLegal help people plan for some of the most difficult times in their lives; then we guide them when those times come.
Make an appointment to meet with CunninghamLegal for California Estate Planning and Trust Administration. We have offices throughout California, and we offer in-person, phone, and Zoom appointments. Just call (866) 988-3956 or book an appointment online.
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We look forward to working with you!
Best, Jim
James L. Cunningham Jr., Esq.
Founder, CunninghamLegal
At CunninghamLegal, we guide savvy, caring families in the protection and transfer of multi-generational wealth.
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