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The parent-child exclusion can be enormously beneficial to children who seek to maintain ownership of inherited real estate. In short, the parent-child exclusion essentially allows a parent to transfer to their child the property tax basis of their primary home plus up $1M in assessed value of other real property. This can be a boon to children because property purchased many decades ago has a low property tax basis which makes keeping the home desirable.
For example, one client I represented a few years ago inherited a home from his late mother who purchased her home in the 1960s. Since the transfer qualified for the parent-child exclusion, the son was able to "inherit" his mother's property tax basis, which was minimal. Hence, his property tax payments were around $600 whereas without the benefit of the parent-child exclusion his property tax payments would be around $5,000. While this does not seem like an eye-popping discrepancy, this payment is annually made. Therefore, the property tax savings are magnified given that the son can reap the benefits for years to come.
One dilemma though that parents face when deciding how to structure their estate is with rental property. While rental property fits within the "other real property" parameters of the parent-child exclusion, the issue of personal liability remains. That is, if a person owns rental property in their individual name, they are personally liable for the debts of the rental property. For instance, if the tenant slips and falls, the tenant may sue for redress of injury in hopes of obtaining a judgment against the landlord/owner. If successful, this judgment can be then be attached to the rental property, and more importantly, the individual himself. Thus, the personal assets of the individual, e.g. bank accounts, stocks, bonds, mutual funds, etc., are subject to attachment.
One way to shield oneself from personal liability in this situation is to create a business entity to own the real estate. Under this scenario, the landlord/owner would ordinarily not be personally liable for any judgments that arise from ownership of the rental property. It would be reasonable to say that at least thousands of Californians have established LLCs for this purpose, i.e. own rental property to avoid personal liability.
The problem is that the California code does not permit real estate owned through a business entity to be eligible for the parent-child exclusion. Penner v. County of Santa Barbara (1995) 37 CA4th 1672. In Penner, a parent's unsuccessful attempt to transfer real estate to her children via a limited partnership resulted in the property taxes being increased from $337,276 to $2,300,000 because it did not qualify for the parent-child exclusion. The court noted that "property must be transferred from one natural person to another" to qualify for the parent-child exclusion. Since the partnership, a business entity, was not a natural person, it failed to qualify for the parent-child exclusion.
A parent owning rental property is thus faced with two competing issues, (1) the parent-child exclusion and (2) liability protection. In this case, a parent cannot have their cake and eat it too seemingly. Either the parent can keep the rental property in their individual name and risk personal liability, or they can transfer the rental property into a business entity, typically an LLC, but lose the potential benefit of the parent-child exclusion. One solution to this dilemma is to purchase umbrella insurance for the rental property and keep the rental property in the individual's name. This method maintains eligibility for the parent-child exclusion and minimizes the effects of personal liability because of the availability of insurance proceeds. The problem is the potential cost of an umbrella policy and the policy limits for an umbrella policy. In law, much like life, there is no perfect solution.
One of the most common property tax exemptions is the parent-child exclusion. The exclusion allows a parent to transfer their residence plus other property to their child without property tax re-assessment, or in the correct legal terminology, the transfer does not constitute a "change of ownership."
The amount of property that can be transferred from parent to child is quite large. Each parent may transfer their personal residence plus up to $1M in full cash value property to the child or children without a change in ownership. Cal Const art XIIIA, §2(h); Rev & T C §63.1. It should be noted that "full cash value" does not mean "fair market value" rather it means means "assessed value." Cal Const art XIIIA, §2(a); Rev & T C §110.1; City & County of San Francisco v County of San Mateo (1995) 10 C4th 554. Assessed value is the figure listed on your property tax bill. As many a homeowner knows, assessed value does not always translate to fair market value because of Prop 13. Thus, a parent could transfer millions of dollars of property to their children if the property has a low assessed value. The following example is illustrative of this.
Wendy was a wealthy widow who owned multiple properties in California. She owned a personal home in Palo Alto, a cabin in Lake Tahoe, a condo in Palm Springs, a beach house in Malibu and a loft in San Francisco. The Palo Alto home's fair market value was $2.5M with an assessed value of $1.2M, the fair market value of the Lake Tahoe cabin was $1.2M with an assessed value of $100,000, the fair market value of the Palm Springs condo was $1.7M with an assessed value of $200,000, the fair market value of the Malibu beach house was $1.8M with an assessed value of $450,000 and the fair market value of the San Francisco loft was $700,000 with an assessed value of $150,000. All of these properties had been purchased by Wendy many decades ago and had substantially increased in value. When Wendy passed away, her children could maintain the property tax basis for each of the properties. For instance, the Palo Alto home, though in excess of $1M, qualified for the personal residence exception and the assessed value of all the other properties did not exceed $1M. Thus, the children would save ten of thousands of dollars on property taxes each year thanks to the parent-child exclusion.
For reference, the parent-child exclusion form is Form BOE-58-AH and can be found on the website of county assessors.
When somebody inherits a home via a will, trust, intestacy or by gift, it is not necessarily true that the value of the home will be re-assessed for property tax purposes.
This can be especially important to a beneficiary who inherited a home from his parents or grandparents since they probably had a low base year value of their home. For example, if Bobby Beneficiary inherited a home, currently valued at $1 million dollars, from his late parents who had purchased the home for $50,000 decades ago, he would not be liable to pay property taxes on the assessed value of $1 million dollars but rather on $50,000, plus annual adjustments. (See Example 4).
Of note, Proposition 13 caps the levying rate for property taxes in California at 1%. Cal Const art XIIIA, §1.
The following are examples of situations in which the transfer will not result in a “change in ownership” and thereby avoid the dreaded re-assessment for property tax purposes.
1. Transfers in which proportional ownership interests remain the same before and after transfer
For example, Husband and Wife own a rental home in joint tenancy (50/50 split) and transfer it to a limited liability company in which they have same membership interest (50/50 split). Rev & T C §62(a).
2. Transfers to revocable trusts
For example, Husband and Wife execute a revocable (living) trust and transfer the home they live in into the trust by transferring title from themselves to the trust by naming the trustee of their revocable trust as owner. Rev & T C §62(d).
3. Interspousal transfers
For example, Husband and Wife own their home in joint tenancy, Husband dies and Wife inherits the other half of the house. Rev & T C §63.
4. Parent-child (or grandparent-grandchild) transfer
For example, in the case of a Parent-Child transfer, Husband and Wife own a home and have one child, Son. Husband and Wife pass away and Son inherits the home. Furthermore, in the case of a Grandparent-Grandchild transfer, Grandparent is only survived by a Grandchild, that is no child of the Grandparent outlives the Grandparent. Rev & T C §62.
5. Persons over age 55 or who are severely and permanently disabled may transfer the base-year value of a residence to a replacement dwelling in the same county, or in another county if the board of supervisors of that county adopts an ordinance granting base-year-value relief to replacement dwellings when the original dwelling was located in another county
As of this writing, seven counties (Alameda, Los Angeles, Orange, San Diego, San Mateo, Santa Clara, and Ventura) have ordinances granting base-year-value relief to replacement dwellings when the original dwelling was located in another county per Rev & T C §§ 68-69.5. For example, Person purchases a home in San Jose (Santa Clara County) and upon reaching the age of 55 sells their home in San Jose in order to purchase a home in Redwood City (San Mateo County) so they can be closer to their family.
