Transferring Property in California for Estate Planning Purposes

The FLP has the double benefit of allowing the survivor’s full step up of basis of the underlining partnership assets for income tax purposes after the first death and following the survivor’s death the limited partner interest can still be discounted for estate tax purposes. The Minority Discount of the value of the Limited Partnership interest allows the transferor to effectively make large annual tax free gifts. In the case of real estate, the due on Sale Clause or Acceleration Clause of the underlining promissory note and deed of trust which secures the real estate to be transferred should be reviewed.

Moreover, care should also be taken to avoid triggering reassessment of property taxes under Proposition 13 and the Change In Ownership Rules found in the Revenue and Taxation Code Sections 60 through 69.5 and the Real Property Tax Rules found in 18 Cal. Co. Regs. Section 62 through Section 471. Section 60 of the Revenue and Taxation Code provides that a change in ownership is a transfer of present interest in California real property including the beneficial use thereof, the value of which is substantially equal to the value of the fee interest.

The transferor must file a Preliminary Change of Ownership Form containing sufficient information in order to determine if a change of ownership has actually occurred. There are several rules that should be addressed with respect to funding the FLP with real property with respect to the change in ownership rules. The Interspousal Transfer Exclusion of Revenue and Taxation Code Section 63 provides that transfers between spouses are not to be considered a change in ownership.

It may be that the property should be transferred out of the name of one spouse into the name of both spouses before it is transferred to the FLP. This may be a good idea even though the property is technically community property held in the name of only one spouse.

Revenue and Taxation Code Section 63.1 provides for a Parent Child Exclusion with respect to the transfer of the transferor’s principal residence as well as the transfer of the first million dollar full cash value of all other California real property. There is also a one million dollar exclusion available for grandchildren if their parents who qualify as the children of the grandparents are deceased as of the date of the purchase or transfer and the grandchild has no surviving parents on the date of the transfer of California real property.

Like the Parent Child Exclusion, a claim form must be filed with the County Assessor’s office in order to claim the exemption. Revenue and Taxation Code Section 65.1 provides that a purchase or change in ownership during one assessment year of interests with a cumulative value of less than 5% of the total value of the real property in question does not constitute a reappraisal of the interest if the fair market value of the interest transferred is less than $10,000. This exclusion starts over each assessment period. Under Revenue and Taxation Code Section 62(a) a Change in Ownership does not occur when the proportional interest in the California real property remains identical before and after the transfer to the legal entity. The property owner can accordingly deed a de minimis interest in real property to the legal entity that will be serving as general partner of the FLP as well as to each of the limited partners. Then the legal entity and all of the other tenants in common/ prospective limited partners can then transfer their proportionate interest in the real property to the FLP and avoid reassessment by utilizing the proportionate interest transfer rule.

Section 64(d) of the Revenue and Taxation Code provides that if property is transferred to a legal entity in a transaction excluded from change in ownership under the proportionate interest transfer rule, those transferor owners are considered the original co-owners. Thereafter, if more than 50% “cumulatively” of the total interest held by the original co-owners in the entity are transferred by the original co-owners the property previously excluded from the assessment is then reassessed. Interspousal transfers, transfers into qualified trusts excluded under Section 62(d) of the Revenue and Taxation Code and proportional transfers excluded under 62.82 are not to be cumulated or counted to determine a change in ownership for purposes of transfers of more than 50%.

Copyright (c) 2011 Jeffrey Matsen