10.31.06
Planning for property tax for heirs.
Let’s continue to consider the example described in the previous post - Mom and Dad buy their home for $100,000 in 1970. Given California’s property tax scheme, as modified by Proposition 13, Mom and Dad will pay state and local property taxes of approximately 1.1% of the assessed value of their home every year - and the assessed value of the home is artificially limited to a growth rate of 2% per year, unless and until the home is sold, at which time it’ll reset to the real fair market value.
In practical terms, this means that Mom & Dad, in 2006, will probably be paying property taxes of between $1,000 and $1,500 per year on their home that’s worth $1,000,000. Let’s imagine another couple purchases the home next door to Mom & Dad, which turns out to be identical to Mom & Dad’s house - and the fair market value (FMV) is also $1,000,000. The new couple will pay approximately $10,000 per year in property tax, where Mom & Dad will pay closer to $1,000.
This ability to retain the old assessed value represents a considerable opportunity to avoid paying property taxes.
An important part of estate planning - often overlooked by attorneys who don’t spend a lot of time working on estate plans, and virtually always overlooked by do-it-yourself software kits and books - is working to preserve the opportunity for heirs to keep the favorable low property tax valuation, in the event that the heirs choose to continue to own the property instead of selling it.
As discussed in the previous message, let’s say that Mom stays in the home after Dad’s passing, and that when Mom passes away the home is now worth $1,500,000. Mom’s estate plan provides that the home will go to her son and her daughter, each taking a 50% interest.
Son and Daughter will get to keep Mom’s favorable property tax valuation; California law provides that property tax will not be reassessed on a transfer between parents and children. The transfer of 1/2 of the property from Mom to Son and 1/2 of the property from Mom to Daughter qualifies as a transfer that’s exempt from reassessment.
Let’s say that Daughter’s already got a house she wants to stay in - but Son wants to live in the family home, so he arranges to get a mortgage so he can purchase Sister’s half from her, and Son can own the home as his own.
The wrong way to set this up is the obvious way - Son buys the other half of the house from Daughter. Now, Son will get to use the favorable valuation for the half of the property he inherited from Mom, since that was an exempt transfer .. but the half of the house that Son purchased from Daughter will be reassessed, because sibling-to-sibling transfers aren’t exempt. Now, instead of paying a property tax bill of $1000 to $1500 per year, Son’s property tax bill will be more like $8000 per year (1/2 of $1,000 + 1/2 of $15,000).
If Son keeps the family home for 20 more years, the failure to plan for favorable property tax treatment will cost Son $140,000 in extra property taxes. If Son then passes the property on to his children at his death, then his kids will be paying property tax bills of $8000 instead of $1000, and the waste continues.
Unfortunately, this approach is what you’re likely to end up with if you (or your attorney, or your do-it-yourself software) aren’t paying attention to property tax planning - it’s easy to conclude “well, there are no estate tax issues here” and stop thinking. That decision to stop thinking can cost heirs an awful lot of money pretty quickly.
This isn’t a hypothetical example - I have worked on several cases where the estate plan was drafted by an attorney (or worse, an annuity salesperson) who didn’t know or care about property tax, and the consequence is tens or hundreds of thousands of dollars in unnecessary property taxes for the heirs.
Jeff said,
November 30, 2006 at 9:45 am
I am in the middle of divorce and I want my wife and kids to remain in our current house. How are property taxes effected if I am bought out for my half of the house?
gbroiles said,
December 4, 2006 at 7:11 am
If this is California property, no problem - that will be a spouse-to-spouse transfer, which is exempt from reassessment.
Your wife should be aware that she’s setting herself up for an unpleasant income tax result, though, if she sells the house in the future.
Cheryl McGovern said,
December 10, 2006 at 2:48 pm
I am a wife who got my ex-husband’s share of the house (I had to take out $400,000 in loans to do so) and now see that I will need to die in this house because of the tax consequences if I sell. I’m under Prop. 13 and will leave the house to my son and daughter and would like to avoid the scenario described on the website where the son has to buy out the daughter’s share and this triggers a sale of 1/2 the value of property and raises the property tax so only 1/2 gets the Prop 13 original tax rate. How do you avoid making this mistake????
Thank you,
Cheryl McGovern
Dorie Poremba said,
February 5, 2007 at 3:11 pm
I would like to transfer title of my home to one of my four children while I am alive. Will my child be eligible for the Prop 13 exemption?
Bill Jaggers said,
May 14, 2007 at 8:28 pm
10.31.06Planning for property tax for heirs.
My wife and I are close to this situation now and I’m trying to set things up correctly.
My wife’s mother is dying from cancer and my wife & her brother will receive the home. My wife and I will then need to do a loan to pay off her brother and obviously, we want to keep the tax base.
What do we need to do??????
Tom said,
June 17, 2007 at 2:07 am
How does the parent child transfer with the property tax effect the step-up basis for capital gains?
Justin mcleod said,
June 26, 2007 at 9:49 am
My Grandmother is 91 and is going to sell her home. They have a living trus set up where my Father and Aunt are the benificiaries. I would like to purchase the house and want to know if I will be able to take advantage of Prop 13.
Maria said,
July 26, 2007 at 1:01 pm
I am in a similar situation - my parents are both now passed … in their trust they left the house to me and my two brothers (1/3 each). My brothers both have houses and I want my parents’ house. I am getting a loan to buy my brothers out of the house - will the property be 2/3 reassessed? is there a legal way for it not to be reassessed?
Gary said,
September 7, 2007 at 7:37 am
The scenario described where son and daughter inherit the house and one buying out the other triggers a reassessment has happened to my brother. As the article described, this was all set up by an attorney who apparently didn’t know what he was doing.
However there was a bill introduced by Audra Strickland (AB 2799) in 2006 that would have eliminated this reassessment on transfers between siblings. I can not find any information on whether or not this bill passed into law. I assume it didn’t, but does anyone know for sure?
Annette Williamson said,
September 17, 2007 at 7:19 am
My husband and I are relocating to Colorado. We are selling our current home to my sister and her fiance for the valued market amount. We pay around $2400 in property tax a year, can this be transfered over to my sister? Or will she have to pay double the property tax since our home market went up since we bought ten years ago.