Property Tax

 Dear Len & Rosie,

My mother has a trust and owns her house within the trust. She rents it out. My brother and I want to hang on to the house after our mother dies and we want to continue to rent it, but we want to avoid the step up basis in property taxes. How can we do this?

Amy

Dear Amy,

You are confused, but that's OK. Taxes are confusing. California's property tax has absolutely nothing to do with capital gains tax, federal estate tax, or basis. And that's good for you.

When your mother dies, everything that she owns is subject to federal estate tax. Fortunately, there will not be any tax due, as long as the total value of your mother's assets upon her death is less than $1,500,000 if she were to die in 2004 or 2005. This amount is called the "unified credit exemption equivalent", which is IRS doublespeak for "What mom can give away now or own on her death tax free." Under the tax law enacted in 2001, this exemption will increase to $2,000,000 in 2006 and $3,500,000 in 2009. In 2010, there will be no estate tax regardless of how rich your mother is, but in 2011, this law will be automatically repealed, and the exemption will fall back down to $1,000,000.

Anything your mother owns on her death that is subject to estate tax gets a step-up in cost basis, whether or not any estate tax has to be paid. Your mother's basis in her rental property, which was originally what she paid for it, will increase to the property's value on her date of death. What this means is that you and your brother can sell the property after your mother's death at its date-of-death value and pay no capital gains tax at all. Also, if you continue to own the property as a rental, you and your brother will have a much greater cost basis that you can depreciate over time to save on your income taxes.

Under Proposition 13 and Proposition 58, your mother can pass to her children her home and the next $1,000,000 of her other real property with no property tax reassessment. That means you and your brother will inherit the rental property and pay the same amount of property tax your mother pays today. You should know, however, that there is no way to avoid a property tax reassessment if you buy out your brother's half of the rental after your mother's death. If you want to wind up owning the entire rental property, your mother should have an attorney review and update her trust. It may be possible for her to leave you the entire rental and to give your brother an equivalent amount of cash. This way, you could inherit the entire property and still avoid a property tax reassessment.

Len & Rosie

Dear Len & Rosie,

Last year, my grandmother gifted her home to me, to protect her home because she was on Medi-Cal. I was shocked to discover the home was reassessed and I received a $6,016 dollar property tax bill! After contacting the assessor, I learned that this could have been avoided if the home was first passed through my mother, retaining the original base value. I also learned that I can still rescind my deed, return the home to grandma, then process the transfer back through my mother, then to me. However, this is not without risk. The process is up to the discretion of the county assessor, based upon original intent. Also, I lose ownership until is comes back from my mother. My brother would have to sign for this since he is now her legal guardian, and I am worried that he will not cooperate. Is it worth the risk?

Gene

Dear Gene,

Under Proposition 13, your grandmother's home was not subject to a property tax reassessment for as long as she owned it, and you may have assumed that the grandparent-to-grandchild transfer reassessment exclusion would have protected you from a property tax increase when your grandmother gave you her home. Unfortunately, you were wrong. It's a bit more complicated than that.

California Revenue and Taxation Code section 63.1 allows grandparents to transfer their home and $1,000,000 of other real property to their grandchildren, but only if their child who is the parent of the grandchildren is dead at the time of the transfer. The grandparents' relationship with the other parent (the son or daughter-in-law) also has to be severed, either by death, divorce, or remarriage.

For the transfer to qualify for the grandparent reassessment exclusion, your mother had to be deceased, and your father, if alive, had to have either divorced your mother prior to her death, or remarried after her death, or was never married to your mother at all. It is confusing, so do not be surprised that you made a mistake.

It can be fixed, but we cannot guarantee to you that the county assessor and your brother will cooperate with you. Your brother, and even your mother, may not like the idea that you are going to wind up with your grandmother's property. So before you do anything, clear it with the county assessor ahead of time and try to get everyone in your family on board.

Len & Rosie

Dear Len & Rosie,

My father died in May of 2004 and I inherited his home. I used the attorney who drew up my father's trust. I did everything that he said to do. Now almost two years later I hear that I should have had the house reassessed at the time of his death so I would be protected from increased property taxes because of Prop. 13 and the trust. As it stands now the assessed value of the house is very low, as is my property tax. I do not want to open a can of worms. I am upset however that my attorney did not advise me to do this at the time. Is it too late?

Kathleen

Dear Kathleen,

Don't worry so much. You have a common misunderstanding. You have confused the assessed value of your home for property tax purposes with the basis value of your home for capital gains tax purposes. They are apples and oranges and have nothing to do with one another. Everything is OK.

When your father died and you inherited his home, the county assessor did not reassess the home and increase the property tax you pay because of the parent-to-child transfer reassessment exclusion enacted by the voters with Proposition 58. Your attorney filed the Prop. 58 claim form when he or she transferred the property to you out of your father's trust.

Property tax has absolutely nothing to do with the basis value of your home. Everything your father owned upon his death, including the home, was subject to federal estate tax. There should have been no estate tax due, because the first $1,500,000 of your father's assets were protected from estate tax by his gift and estate tax unified credit. But because his home was subject to estate tax, its cost basis of the home on your father's date of death.

This is the only reason to have the home appraised (not reassessed). If you obtain a professional appraisal of your home, as of your father's death, then you will be able to calculate the amount of capital gains tax, if any, you'll have to pay if and when you sell the home. Appraising the home will have no effect on your property tax.

It's been two years, but there's no reason why you cannot have an appraisal done now. The home's value two years ago can be calculated easily enough, because appraisers have access to historic data concerning property sales in your community. Just make sure the appraiser is certified, or is a California Probate Referee, so the appraisal will hold some wait if the IRS ever looks at it in an audit.

Len & Rosie

Len Tillem and Rosie McNichol are elder law attorneys. Contact them at 846 Broadway, Sonoma, CA 95476, by phone at (707) 996-4505, or on the Internet at www.lentillem.com. Len also answers legal questions each weekday 3-4pm on Newstalk910AM.