Q. My mom owned her home for 35 years before she recently passed. Her trust leaves it 50-50 to my brother and me. I would like to keep the home by purchasing my brother’s interest for cash, and he is okay with that. Is there a way that we can do this without triggering a property tax reassessment?
A. Yes there is! This is called a Non Pro Rata distribution. To make it work, the transaction must be handled in a special way.
Background: Proposition 13, which California voters passed in the 1970’s to hold the line on property taxes, nevertheless allowed the County Assessor to reassess property whenever there is a “change in ownership”. Proposition 58, which the voters adopted later, provides that a transfer of a home between parent and child would not be considered a “change in ownership”, provided that a Claim for Reassessment Exclusion is timely filed.
Under these Propositions, your purchase of your brother’s 50% interest using your own money would be deemed a “change in ownership” as to that portion, because it would be deemed a non-exempt transfer between siblings, rather than a parent — child transfer. Your purchase would then trigger a reassessment as to that 50%.
Good news, however! There is a workaround that has been approved by the California State Board of Equalization (“BOE”). If — rather than using your own money — the trustee of the trust borrows money from a third-party lender, securing that loan by the home, and then distributes the entire home to you (encumbered by the loan amount) and an equivalent value in cash to your brother, there would then be no change in ownership and no reassessment. You would then be responsible for the loan.
In short, where the trust already has sufficient cash to make the non-pro rata distribution work, then the division can usually be made without reassessment. However, where the trust does not have sufficient cash to make an equal distribution, that is where special borrowing must occur in order to avoid reassessment.
To illustrate how this applies in various fact patterns, consider the following scenarios. In each case assume that the home has a value of $500,000, that the trust does not prohibit a non-pro rata division of assets, that it permits the trustee to borrow money, and that a timely Claim for Reassessment Exclusion is filed.
1) The only asset in the trust is the home. You raise your own $250,000 to buy out the interest of your brother. Change in ownership as to his 50% thus purchased. Reassessment and increase in the property tax bill.
2) The only asset in the trust is the home. At the conclusion of trust administration, it is allocated by deed 50-50 to you and your brother. No change in ownership; No reassessment.
3) The trust is comprised of the home and $500,000 in cash. The home goes to you and all the cash to your brother. Same result as in #2: No change in ownership. No reassessment.
4) The only asset in the trust is the home. Trustee borrows $250,000 from a third-party lender, and distributes the home encumbered by the loan to you and the $250,000 in cash to your brother. Same result as in #2: No change in ownership. No reassessment.
5) The trust is comprised of the home and $100,000 in cash, for a total trust estate of $600,000. Trustee borrows $200,000 from a third-party lender, and distributes the home encumbered by the loan to you and $300,000 in cash to your brother. Same result as in #2: No change in ownership. No reassessment.
Note: These transactions must be handled very carefully, a suitable lender engaged and adequate documentation furnished to the County Assessor. This is not a do-it-yourself project, and it is strongly recommended that these transactions be fully supervised by an attorney familiar with trust administration. The same concept may also be used in a probate administration, but court approval may be required if all parties do not agree.
If handled correctly, preserving a parent’s low property tax base can result in thousands of dollars in savings over time and help make retention of the family home a more affordable option.
Note: As regards the borrowing in Options #4 and #5 above, there may be other approaches to preserving the parent–child exclusion, which would not require borrowing from a third-party lender. However, these other approach would require that specific language be in the trust document, itself. Examples: The full parent-child exclusion would apply where the trust instrument, itself, (1) gives one child the first option to purchase real property (“right of first refusal”): BOE Letter 625.0233 (August 19, 2013); or (2) the trust instrument gives one child the right to include the trust realty as part of his share, on condition that he provide sufficient assets to the other child to equalize the distribution. BOE Letter 625.0235.025 (February 22, 2010).
CAUTION: Before undertaking any of the strategies above, consider the effect of Proposition 19, narrowly passed by the electorate on November 3, 2020.Its provisions, making dramatic change to the Parent–Child Exclusion, become effective February 16, 2021. See the following article on topic: “Preservation of Parent’s Low Property Tax Rate Soon To Be More Difficult For Children: Planning Window Closing”. Prop 19 must now be considered before undertaking any of the strategies outlined above, and will be controlling to the extent of any conflict with prior law and prior BOE Letters and opinions, including those referenced below. That said, we have secured informal advice from the BOE that the Non-Pro Rata Distribution discussed herein has not been changed by Proposition 19, provided that other Prop 19 criteria are met as to the home, citing BOE Letter of 02/16/2021 entitled “Intergenerational Transfer Exclusion Guidance. Questions and Answers”, calling attention to Q&A # 25 on page 5 of this Letter.
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References: (1) State Board of Equalization, “Parent-Child Exclusion”, Assignment No: 09-243. February 22, 2010; (2) BOE letter to Honorable Stepeh L. Vagnini, March 10, 2005, Probate and Non-Pro Rata Distributions/Sale to a Child, No 625-0251; (3) BOE Letter 625.0252, March 27, 2013, Probate and Non-Pro Rata Distribution; (4) Effect of Disclaimer. BOE Letter NO. 625-0082; (5) FAQ’s Re: Parent–Child Transfers; No. 625-0000; (6) BOE Opinion No. 2008/018 dated February 29, 2008; (7) California Probate Code §16246 (Trust Administration; [trustee may distribute assets in kind pro rata or non pro rata].) and §11950 (Probate Administration); and (8) Chapter 12 of the Assessors Handbook, specifically example 12-6 at page 90; (8) BOE Letter No. 0208/018 dated 2/29/2008 on the Parent-Child and Grandparent–Grandchild Exclusions, especially Q&A # 26 [“step-transaction doctrine” discussed in Q & A section, page 8].; (9) Change in Ownership–Life Estate Remainder Interest Transfers; Assignment No: 14-115 (April 7, 2015); (10) BOE Letter No. 2008/018 (2/29/2008) and, specifically, Q&A #’s 35, 36; (11) Property Tax Annotation 625.0235.005; BOE Letter to the Honorable Stephen L. Vagnini [a trustee who elects non-pro rata distributions may encumber trust property with a loan, distribute the loan proceeds to other beneficiaries, and the encumbered real property to one beneficiary, in order to equalize the distribution, (08/04/2003); (12) Durante v. County of Santa Clara (11/30/2018) [Court found that a Life Estate is substantially similar to a fee interest, and therefore the creation and transfer of a life estate, from sibling to sibling, was a change of ownership triggering reassessment as to the 50% interest of the sibling making the Life Estate transfer; 6th DCA; 29 Cal.App.5th 839 (11/30/2018)]. A general reference to property taxes is available on the website of the Alameda County Assessor. Click here to view. CEB, Estate Planning, “Nonprorata Allocation of Property”, ☻1 15.16.
Joseph Bohnett v. County of Santa Barbara, (DCA 2nd. 01.19.2021), denying a Claim for Parent-Child Exclusion where one of 13 children/beneficiaries purchased his deceased parents’ former residence, not from the trust, but from his other siblings. This decision basically affirms the strategy discussed above and the need for the Trustee to be the party obtaining the equalizing loan, for the Trustee to make the equalizing distribution, and for the Trustee to be the party signing the deed. The Cal.4th case citation is not available as of the date of this addition to these references.
On Nov. 3, 2020, voters in California will decide whether to modify this arrangement via proposed Proposition 19; Click here for a summary of how the proposed Proposition would modify current law. Update: it passed by a narrow margin. See “Caution” above.
Transfer to A Trust: [Cal Rev & T Code § 61(h); BOE Property Tax Rules 462.160]; Transfer with Reserved Life Estate: [Cal Rev & T Code § 61(g) and 62(e); Rule 462.060]