The following was written by Attorney Jack E. Stephens, for the professional manual, Rules of Trust Administration in California, regarding the administration of a Living Trust on the death of a Trustor. This is Part 6 of an ongoing series.
Real Property Issues
If you are having insomnia issues, try a couple of chapters of the change of ownership issues in the Revenue and Taxation Code, hereafter the “Code”. How can passing a plot of dirt get so complicated? Let’s start with Prop. 58, approved in California in 1986, which allowed for certain exclusions from property reassessment on transfer. Basically it excluded from “change in ownership” the purchase or transfer of:
- A principal residence between parents and their children; and
- The first $1 Million of the full cash value of all other real property between parents and children.
In 1996, Prop. 193 allowed for the exclusion from grandparents to grandchildren if the parents of the children were deceased at the date of the transfer. Family Code §297.5 controls the definition of “children” in terms of the rights of registered domestic partners. As a result, beginning January 1, 2005, any relationship between parents and children established by a registered domestic partnership is provided the same treatment as if established by marriage for the purposes of the parent-child exclusion.
The Code, §63.1 (c) defines children as any of the following:
- Any child born of the parent or parents, except a child who has been adopted by another person or persons.
- Any stepchild or spouse of that stepchild while the relationship of stepparent and stepchild exists, which means until the marriage on which the relationship is based is terminated by divorce or, if terminated by death, until the remarriage of the surviving stepparent. As of January 1, 2005, a registered domestic partner is a parent to a partner’s child.
- Any son-in-law or daughter-in-law of the parent(s) while the in-law relationship exists, which means until the marriage on which the relationship is based is terminated by divorce, or, if terminated by death, until the remarriage of the surviving son-in-law or daughter-in-law. As of January 1, 2005, an in-law child includes a registered domestic partner.
- Any child statutorily adopted by the parent(s) by the age of 18.
- Any foster child of a state-licensed foster parent if that child was not, because of a legal barrier, adopted by the foster parent before the child aged out of the foster care system.
A grandchild is defined as any child of the child of the grandparent(s). For a transfer to qualify for the grandparent-grandchild exclusion, both parents of the grandchild must be deceased at the time of the transfer with one exception. For transfers made after January 1, 2006, a son-in-law or daughter-in-law of the grandparent who is a step-parent to the grandchild need not be deceased at the date of transfer.
Disclaimers: Disclaimers will not qualify for the exclusion.
Example: Mother M, who is living, disclaims her inherited home from her mother GM. Even though the grandchildren, children of M, will receive the home by virtue of the Trust provisions, the grandparent-grandchildren exclusion is not available since M is still living. Being treated as deceased or being deceased are not the same for the tax assessor. A parent must be actually deceased prior to the transfer to qualify for the exclusion.
The exclusion applies to voluntary purchasers and transfers as well as Court ordered (involuntary) transfers.
If the real property is received by way of inheritance, it will qualify for the exclusion as long as it is received from an individual and not a legal entity. If the residence or other real property is in an LLC or Family Limited Partnership (FLP), the property should be removed from such entity before being transferred to the eligible persons.
Trusts
Transfers of real property through the medium of a Trust is normally not a problem in qualifying for the exclusions. From a property tax perspective, the Assessor’s office looks through the Trust to the present beneficial owner. As a result, the transfers are being seen as transfers between individuals and not a form of legal entity like an LLC.
Example: Jake creates a Living Trust in which he transfers his home by deed. The initial transfer to the Trust is excluded from a change in ownership based on Code §62 (d). He makes Jane, his daughter, as the Trust beneficiary. On Jake’s death, the home vests in Jane in the now irrevocable Trust. The change in the present beneficial ownership, which occurred at Jake’s death, is treated as a transfer from Jake, the parent, to Jane, the child. Under the parent-child exclusion it is excluded from a change in ownership repercussions of a property reassessment assuming the claim form is timely filed. The distribution by deed to Jane upon termination of the Trust is merely a change in holding title since Jane’s interest became possessory at Jake’s death.
A life estate is considered a change of ownership.
Example: The Trust provides for a life estate in the home for Chuck’s girlfriend Cathy, remainder to his children. The creation of the life estate is a change of ownership, creating reassessment, as no exclusion applies because Cathy is a girlfriend. Upon Cathy’s death, the life estate terminates and there is another change in ownership in which the exclusion may be applied. When a life estate terminates on the death of the holder, the transfer to the remainderman is from the original transferor of the remainder interest, not the life tenant. This is based on the fact that Code §§61 (g) and (h) and 62 (d) identify the grantor of the life estate as the “transferor” of the remainder interest, not the life tenant. Assuming all other requirements of filing are satisfied, the property will not be reassessed upon the termination of the life estate and the property will retain the base year value of the life tenant.
Pro Rata v. Non-Pro Rata Distributions
Probate Code §16246 allows for divided or undivided distributions by the Trustee and in kind distributions prorata or non-prorata. This allows ultimate flexibility for this purpose unless the Trust provisions state restrictions otherwise. Assuming no restrictions, the Trustee could transfer the home to one child and other assets of equal value to the other children. The problem arises when prorata distribution is required by the Trust and one child wants a buyout arrangement on the home. If the Trustee transfers the home in equal shares to all the children, there can only be a transfer or sale of the home to the interested child by the other children. This would, in effect, negate the parent-child transfer exclusion.
Example: Trustor prepares a Trust to include her home and other assets. The Trust provides for a prorata distribution. Trustor’s daughter, Mae, has always expressed an interest in the home. Since the Trust requires a prorata distribution, the Trustee is required to distribute the home in 3 equal shares to the children. Mae, then, would have to purchase two-thirds of the home from her siblings. Since this transfer will not be protected by the parent-child exclusion in the original transfer from the Trust, two-thirds of the property will be reassessed on the transfer to Mae from her siblings.
Tip: Unless there is some other reason to retain the prorata distribution, it should be removed in these circumstances. That leaves the Trustee the flexibility to distribute divided or undivided assets non-prorata. Also, if a child has expressed an interest in a particular piece of property, include a first option to purchase or specific provision bequesting such property to that child. This will ensure that the parent-child exclusion can be utilized to avoid reassessment.
Remember, the Parent-Child Exclusion Form must be timely filed. The Statutory provisions for filing found in Rev. And Tax Code §63.1 (e)(1) are as follows: (e)(1) The State Board of Equalization shall design the form for claiming eligibility. Except as provided in paragraph (2), any claim under this section shall be filed:
(A) For transfers of real property between parents and their children occurring prior to September 30, 1990, within three years after the date of the purchase or transfer of real property for which the claim is filed.
(B) For transfers of real property between parents and their children occurring on or after September 30, 1990, and for the purchase or transfer of real property between grandparents and their grandchildren occurring on or after March 27, 1996, within three years after the date of the purchase or transfer of real property for which the claim is filed, or prior to transfer of the real property to a third party, whichever is earlier.
(C) Notwithstanding subparagraphs (A) and (B), a claim shall be deemed to be timely filed if it is filed within six months after the date of mailing of a notice of supplemental or escape assessment, issued as a result of the purchase or transfer of real property for which the claim is filed.
Principal Residence:
A change of ownership does not include the purchase or transfer between the parents and their children of the principal residence. A principal residence is defined as the residence that is eligible for either the homeowner’s exemption or a disabled veteran’s exemption as a result of ownership and occupation. Code § 63.1(b)(1).
There is no limit on the number of principal residences that can be transferred in a lifetime. Thus, a parent can sell or transfer the original principal residence to a child and purchase another residence. This residence could be left to the same child by inheritance. As long as the real property is the principal residence at date of the transfer, the parent-child exclusion applies. With the exception of the following, there is no dollar amount exclusion limit on principal residence transfers. However, the portion of the land consisting of a reasonable size underlying the residence may be considered eligible for the parent-child exclusion. The issue of a reasonable size is determined by the county assessor. Any excess land not considered as reasonable would then become eligible for the additional $1 Million limit exclusion.
$1 Million Additional Exclusion
The additional exclusion of $1 Million of non-residence real property is valued at the full cash value. Code § 110.1 indicates that the “full cash value” means the adjusted base year value prior to the date of transfer. It is important to realize that each parent has an additional $1 Million exclusion to transfer to the children. As a result, clients who have multiple real properties should plan accordingly in their estate plans to take advantage of the parent-child exclusion. This issue becomes important when planning with A-B Trusts.
Example: Joe and Jodi, husband and wife, own several pieces of real estate as community property. Each of them can transfer $1 Million of the presently assessed value (the adjustable base year value) to their children. If one spouse dies leaving all property to the surviving spouse, $1 Million in exclusion from reassessment is lost.When there are multiple properties transferred, the properties that transfer first with properly filed claims obtain the $1 Million exclusion.
Example: Parent Zack transfers a rental property #1 assessed at $500,000 to his son Jack who does not file a parent-child exclusion form. On Zack’s death, he leaves another rental property #2 assessed at $800,000 to son Mack. Mack timely files the parent-child exclusion for the entire amount of the inherited rental property #2. If Jack then subsequently and timely files for the exclusion on the previous transfer of rental property #1, he will obtain an exclusion of $200,000 representing the remainder of the $1 Million exclusion from Zack.
Clearing Title:
If there is real property in the estate of the decedent it needs to be transferred into the name of the Successor Trustee. This is basically the action taken to remove the decedent’s name from title on the property. For example, the decedent may have held title as Trustee or in a Joint Tenancy. The decedent’s name is typically removed by affidavit of the surviving title owner. When the property is held in Trust, we file an Affidavit of Death of Trustee (See Form # 8 in the Form File). The affidavit is signed by the Successor Trustee which basically indicates that the former Trustee is deceased and identifies the property by legal description. This document clears the title chain so that the Successor Trustee is now the legal title holder as Trustee.
If the real property is to be transferred out of the Trust based on the distribution provisions, the new Trustee will sign the deed of transfer. It is important that these two documents be filed in order and labeled #1 and #2 with the recorder’s office. If the deed is filed before the Affidavit of Death of Trustee, there could be a cloud on title.
Example: Frances is Trustee of her Trust when she becomes deceased. Her daughter Susan is the Successor Trustee and is to transfer the property to her and her brother in equal shares. Susan, as the new Trustee, signs both documents but the deed is filed first. The chain of title reveals that the property was titled in Frances’ name as Trustee but Susan signed the deed of transfer. Since the Affidavit of Death was filed out of sequence, there could be a cloud on title.
Therefore, it is important to remember- if you mail the documents, or personally file them, be sure to give them the “ole 1-2” in the proper order.