Many property owners have enjoyed the protection of Proposition 13 and the 2% annual cap on the increase of assessed value for decades. As a result, the difference in fair market value of the property can often exceed the assessed value by millions of dollars. You may wonder, is there any way to transfer or sell the property without having the property reassessed at the fair market value? Fortunately, the answer is YES: there are some interesting ways to transfer property while avoiding reassessment.
The Revenue & Tax Code contains something called a proportional interest exclusion in Section 62(a)(2). Under this code, you may transfer property into a legal entity without reassessment as long as the resulting ownership interest in the legal entity is proportional to the ownership interest of the original property.
Let’s say John Brown and Mary Smith each own half of a commercial building. They decide to form an LLC and want to transfer the building into the LLC. John and Mary set up the LLC so that each owns 50% of the LLC. The transfer of property does not trigger reassessment because of the proportional interest exclusion. John and Mary are called original co-owners at this point.
Rev & Tax Code Section 64(a) provides a way for John and Mary to sell a portion of the LLC without triggering reassessment. In general, selling or transferring ownership interest in a legal entity does not trigger reassessment of the property owned by the entity. There are two exceptions: The property will be reassessed when there is a change in control (when an owner gains over 50% of the interest in the company) and when there is an original co-owner change in ownership (when the original co-owners have transferred greater than 50% of their interests).
For example, John may sell or transfer his 50% interest in the LLC to Andrew, while Mary retains her 50% interest. Now the original co-owners have transferred 50% of their interest, but did not exceed 50%, so there is no reassessment. Andrew may sell his share to anyone except Mary, since if Mary gains over 50% ownership interest in the LLC, the property will be reassessed. Andrew may sell or transfer some or all of his interest freely. However, if Mary transfers any of her interest, over 50% of the original co-owner interest will be transferred, and the property will be reassessed at that point.
This is just an example of one way of avoiding reassessment. We have helped clients take advantage of reassessment exemptions in their succession and estate planning. Call LSL CPAs at 714.569.1000 for more information.
