California estate planning and administration attorneys have been advising their clients on the best ways to maximize the parent to child exclusion created by California Proposition 58 since it was approved by voters in 1986. Since then, the tax collector and courts have chipped away at this law to narrowly define it and reassess property taxes for any transfer that does not strictly conform to the letter of the law. Among trust and estate practitioners, it is commonly understood that there are perils in administering a typical trust with equal distribution provisions for the children. It is understood that distributing real property to one child, when there are insufficient trust or estate assets for an equal distribution to the other child(ren) could result in the County Assessor determining that it is not a parent to child transfer, but a transfer between siblings as to the unequal share. However, the newly minted Proposition 19, which becomes effective on February 16, 2021 and the recent ruling by the California Second District Court of Appeal in Bohnett v. County of Santa Bohnett v. County of Santa Barbara, B303520 (2021) have the most skilled and experienced practitioners debating each other over how best to advise their clients. What we can agree on is that the parent to child exclusion rule is on the proverbial “ropes” and you need skilled coach in your corner if you want to have any chance of successfully avoiding a “total knock out” of the parent to child exclusion for your children or you if you are the beneficiary of your parent’s estate or trust.
As the ruling in Bohnett demonstrates, the ability to successfully leverage the parent to child exclusion for transfer of real property was already fraught with challenges, but now adding Proposition 19 and the restrictions which generally provide that the property must be the parent’s principal residence and be transferred to child(ren) who intend to occupy the property as a principal residence makes advising estate planning clients and fiduciaries of trusts even more complicated. For those unfamiliar with the parent to
child exclusion, the Bohnett ruling provided a history lesson:
“Proposition 13, approved by the voters on June 6, 1978, provides that the tax on real property shall be based on “the appraised value of real property when purchased, newly constructed, or a change in ownership has occurred.” (Cal. Const., art. XIIIA, § 2, subd. (a).) An exception for parent-child transfers was added by Proposition 58, approved by the voters on November 4, 1986. It provides, “the terms ‘purchased’ and ‘change in ownership’ do not include the purchase or transfer of the principal residence of the transferor in the case of a purchase or transfer between parents and their children.” (Cal. Const., art. XIIIA, § 2, subd. (h)(1).)
Proposition 58 is construed in Revenue and Taxation Code section 63.1. It provides that for purposes of the exemption, “children” includes a stepchild, son-in-law, or daughter-in-law. (Rev. & Tax. Code, § 63.1, subd. (c)(3)(B) & (C).) The statutory scheme “shall be liberally construed in order to carry out the intent of Proposition 58 . . . to exclude from change in ownership purchases or transfers between parents and their children described therein.” (Stats. 1987, ch. 48, § 2.)
As a “general principle[,] . . . transfers by reason of death occur at the time of death.” (Rev. & Tax. Code, § 63.1, subd. (g).) A transfer includes “transfer of the present beneficial 5 ownership of property . . . through the medium of an inter vivos or testamentary trust.” (Rev. & Tax. Code, § 63.1, subd. (c)(9); see Cal. Code Regs., tit. 18, § 462.001.) A transfer of ownership occurs when a revocable trust including an interest in real property that vests in persons other than the trustor or their spouse becomes irrevocable. (Rev. & Tax. Code, § 61, subd. (h); Cal. Code Regs., tit. 18, §§ 462.160, subd. (b)(2), 462.260, subd. (d)(1).) “With the creation of an irrevocable trust, trust beneficiaries acquire a vested and present beneficial interest in the trust property.” (Empire Properties, supra, 44 Cal.App.4th at p. 787.)”
In the Bohnett case, the facts were that the parents of Mr. Bohnett, Bernard Wehe and Sheila Wehe created a trust and they transferred title to their primary residence into the name of their trust. The trust provided that upon the deaths of Bernard and Sheila, the trust estate was to be distributed equally among their 13 children, including Mr. Bohnett. Sheila died in 2003. Bernard died in 2008. It took the children several years to decide what to do with the property, so they rented it until 2013 when the Bohnetts purchased the property from the trust an obtained a loan to fund the purchase. Prior to the purchase in 2013, a Claim for Reassessment Exclusion for a Parent to Child Transfer form was filed with the Santa Barbara Assessor claiming that all 13 children were beneficiaries of the property. Additionally, the 13 children of Bernard and Sheila shared in the income from the property.
In 2013 when the Bohnetts purchased the property from the trust, a second Claim for Reassessment Exclusion for a Parent to Child Transfer was filed, which attempted to exercise the parent to child exclusion and maintain the property tax bases for the property, which was $157,731. Instead, 12/13ths of the property was reassessed to a value of $962,873 for 2012/2013 and $963,114 for 2013/2014. The Bohnetts sued to reverse this reassessment and lost.
The rationale for the ruling against the Bohnetts was that the purchase of the property was from the other 12 children of Bernard and Sheila and not from the trust.
Although the court did find that equitable title effectively vested to the trust beneficiaries on the death of Bernard, that did not necessarily rule out the ability of the Bohnetts to exercise the parent to child exclusion as to 100% of the property. The real issue was that the trustee had filed the Claim for Reassessment Exclusion for a Parent to Child Transfer form thereby confirming that all 13 beneficiaries would be receiving an interest in the property.
The Bohnett ruling stopped short of explaining how the transaction could have been handled to allow the Bohnetts to exercise the parent to child exclusion on 100% of the transfer. However, it did allude that it may have been possible. The court offered some insight into that concept in recognizing that the terms of the trust granted the trustee “the authority to distribute property ‘in divided or undivided interests and to adjust resulting differences in valuation.’(Prob. Code, § 16246.)” and that: “The trust authorized the trustee to partition the property, to distribute disproportionate shares of an asset, and to sell property as necessary to distribute the estate. The trustee also had the power to encumber trust property (Prob. Code, § 16228.)” In other words, if the other assets of the trust were sufficient and/or had the trustee used financing and other assets to equalize the distribution between the other 12 beneficiaries, which was a power of the trustee, Mr. Bohnett may have been able to receive the property as his distributive share of the trust. The result could have been that the other 12 beneficiaries would have received cash or other assets of an equivalent value of the property transferred to the Bohnetts. If the trustee had not filed the first Claim for Reassessment Exclusion for a Parent to Child Transfer form and taken these steps, the transfer of the property could have been from Bernard and Sheila’s trust and not a purchase from Mr. Bohnett’s siblings, thereby preserving the parent to child exclusion and saving the Bohnetts approximately $8,000 per year in property taxes.
With Proposition 19, the Bohnett ruling becomes even more important, because in general Proposition 19 does not allow for a parent to child exclusion unless it was the parent’s primary residence, and it will be the primary residence of the child(ren). While it may be possible that some siblings would agree to live together in the family home, that will likely be the exception and not the rule. As such, trusts need to be carefully crafted to allow the trustee the power to borrow, distribute divided, undivided, and in-kind or cash assets. Thereafter, the trustee needs to carefully consider the desires of the beneficiaries and decide how the assets will be distributed prior to filing a Claim for Reassessment Exclusion for a Parent to Child Transfer form with the County Assessor. If there is one sibling that wants the property and sufficient assets or the ability to borrow cash to provide sufficient assets to the other child(ren) and make equal distribution, it should be determined prior to filing a Claim for Reassessment Exclusion for a Parent to Child Transfer.
What does this mean to you? If you are a parent wanting to leave your investment real property to your children and save them increased property taxes, you have until February 15, 2021 to take advantage of the parent to child exclusion in its current form. You should consult a qualified estate planning attorney immediately. If you want to leave your residence to your children, you should still consult a qualified estate planner and execute a complete estate plan, including a trust that provides broad powers to the trustee. Based on Proposition 19, the Bohnett ruling and statutory and decisional authority, it is almost a certainty that children of a decedent who dies (after February 15, 2021) owning real property, without a trust, will be facing at least a partial reassessment to date of death value, unless it is the decedent’s primary residence and the child(ren) intend to occupy it as a primary residence.
If you are a successor trustee, you should not try to save money, as so many trustees do, and administer the trust without the aide of a qualified trust and estate attorney. You should retain a qualified trust and estate attorney to advise you on the administration and the best way to maintain the tax bases for property tax purposes. Your intended good deed of saving the trust attorney’s fees could result in you exposing yourself to personal liability for not properly administering the trust.
Don’t wait until it’s too late. Contact Cannon Legal Firm today for a free consultation to review your existing estate plan; to create a new one; advise you on administering a trust or estate; or if you are a beneficiary who wants to know your rights.