Commentary: Consider property taxes in succession planning


Issue Date: November 11, 2015
By John Gamper
John Gamper
California property tax law can affect intergenerational transfers of family farms and ranches, and should be factored into succession plans.

The intergenerational transfer of the family farm can be both financially and emotionally draining. The tax consequences associated with loss of the patriarch and matriarch of the family can be so expensive that the heirs have to sell all or part of the farm or ranch just to settle up with the taxman. Equally challenging are the impacts on family dynamics when heirs have different financial expectations. Some may want to continue to work the land while others may want to cash out.

Books have been written and legal careers made on the intricacies of the federal estate tax and importance of succession planning. Many believe that with appropriate capitalization, adequate succession planning and good communication among the potential heirs, a family farm can continue to thrive for generations.

With property tax bills arriving recently from your county assessor, it's a good time to take a look at how California's property tax law can impact these involuntary transfers. I am not a certified financial planner or tax attorney, so what follows is meant as a heads-up to help ensure that you get the best advice from your succession-planning professional.

In November 1986, Proposition 58 won approval from three-fourths of California voters. This legislatively proposed constitutional amendment broadened the circumstances under which real property can be transferred between parents and children without triggering reassessment under the definition of change of ownership.

Proposition 58 applied to real estate transfers of the family's principal residence, regardless of value, and to a limited amount of all other real property. The limit on other real property applies to the first $1 million of assessed value, regardless of the number of properties transferred.

As you know, thanks to Proposition 13, assessed value can be significantly lower than market value, especially when land has been held for several generations. Both parents can combine their exclusions for a limit of $2 million, but any property transferred above the assessed value limit is subject to reassessment.

Two things must be remembered regarding the transfer of real property between parents and children:

  • The exclusion is not automatic; you must file a timely "Claim for Reassessment Exclusion" form with the county assessor's office. You should consider doing this immediately, to avoid complications down the road.
  • Transfers between legal entities (i.e., corporations, partnerships) that are owned by parents or children do not qualify. It is vital that your tax attorney or financial planner understands this crucial limiting factor of Proposition 58.

The popular use of Subchapter S corporations and limited liability companies, or LLCs, to protect the farm and other assets from lawsuits can trigger reassessment, because the definition of "real property" does not include any interest in a legal entity. For example, transferring your property to an LLC and then transferring at least a majority interest to your child can result in a change in ownership and reassessment of the entire property. Thus, for property tax purposes one should consider simply transferring the property directly to the child, rather than going through an entity such as an LLC.

Also, a transfer to or from a trust is treated as a transfer to or from the trustor personally, provided the trust is revocable. The use of revocable living trusts represents an effective option if you are not ready to transfer your property now, but want to make provisions for the transfer after your death.

A living trust is termed "revocable" when the trustor reserves the right to terminate the trust and retain all trust property. When real property is placed in a revocable living trust, it does not trigger a change in ownership and thus no reassessment. A revocable living trust should clearly specify that it is the trustor's desire to qualify the property for the parent-child exclusion.

As noted above, when property is left to more than one child, complications can occur when one child wants to continue farming while the other(s) want money or other assets of equal value. If a trust simply provides for equal shares in the enterprise, one child will have to buy out the others' interest. Since sibling-to-sibling transfers do not qualify for an exclusion, this change in ownership will trigger reassessment of the real property.

This scenario can be avoided with proper planning and good communication among those involved. For example, a trust can provide for a "non-pro rata" distribution of shares. This type of distribution, perhaps offset by other gifts of assets, can allow one child to inherit the farm's real property without triggering reassessment.

Avoiding reassessment of the farm or ranch in the intergenerational transfer of the property can be crucial to the long-term viability of the operation, especially considering current agricultural land values and the ever-present hammer of the federal estate tax.

Is it time to start the process of comprehensive succession planning for your farming or ranching operation? It can help provide financial security in retirement while ensuring that your family business stays in the family.

(John Gamper is director of taxation and land use for the California Farm Bureau Federation. He may be reached at jgamper@cfbf.com.)

Permission for use is granted, however, credit must be made to the California Farm Bureau Federation when reprinting this item.