PROPOSITION 13 REASSESSMENTS ON PROPERTIES HELD IN LEGAL ENTITIES

PROPOSITION 13 REASSESSMENTS ON PROPERTIES HELD IN LEGAL ENTITIES

Today, many people are generally aware of California’s Proposition 13, and its limitations on property taxes. Also, many people today choose to own real estate inside of a legal entity for the personal liability protection legal entities provide. What is not generally understood, are some of the exclusive ways Proposition 13 reassessments can be triggered for properties owned inside of legal entities.

We begin by covering the basics of the specific Proposition 13 rules for legal entities, and then discuss the potential ramifications of not complying with those rules and how the Williamson Act can play a role for entities who own agricultural land.

Proposition 13 Reassessments.

On June 6, 1978, California’s Proposition 13 (“Prop 13”) was approved. Prop 13 rolled back real estate assessments to the March 1, 1975 market values, and limited future property tax increases to a maximum of 2% per year.

Generally, transfers of title and new construction are events that trigger reassessments under Prop 13. When a property is reassessed, a new base year value for the property is established which is equal to the market value of the property at the time of the triggering event (the “Prop 13 Value”).

When a legal entity (LLC, corporation, etc.) holds real property in California, additional rules apply. Properties held by legal entities are deemed to have been transferred when there has been either a change in control or a change in ownership. Both are defined below.

• A change in control (“CIC”) occurs when a person or entity obtains more than 50% of the ownership interest in the legal entity. When that occurs, a 100% reassessment is triggered.
  • Example: Adam and Bob both own interest in a corporation which owns the family ranch in California. On July 1 Adam sells his 25% ownership interest in the corporation to Bob, who already owns a 30% interest in the same corporation. After the sale, Bob now owns 55% of the corporation, and thus the transfer from Adam to Bob causes a CIC and triggers a Prop 13 reassessment on 100% of the family ranch as of July 1.
• A change in ownership (“CIO”) occurs when one or more transfers results in cumulatively more than 50% of original co-owners’ interest in the legal entity changing hands. When that occurs, a 100% reassessment is triggered.
  • Example: Rachel and Gloria are the original co-owners in an LLC which owns a beach house in California. Rachel has a 60% ownership interest in the LLC, and Gloria owns the remaining 40% interest. On July 1 Rachel sells 30% of her ownership interest in the LLC to her son Grant. On December 1 Rachel sells her remaining 30% ownership interest to her other son Steve. The December 1 transfer to Steve, along with the previous transfer to Grant, cumulatively resulted in more than 50% of the original owners’ interest in the LLC changing hands, and thus the transfer to Steve causes a CIO and triggers a Prop 13 reassessment on 100% of the beach house as of December 1.

Reporting a CIC or CIO.

It is the legal entity’s responsibility to self-report when a CIC or a CIO has occurred. This can be accomplished by filing a Statement of Change in Control and Ownership of Legal Entities form with the State Board of Equalization within 90 days of a CIC or CIO of the legal entity, if as of that date, that legal entity owned an interest in California real property.

Often, owners of a legal entities are unaware of their responsibility to self-report when a CIC or a CIO has occurred. Sometimes, some owners are simply unaware that a CIC or a CIO has occurred at all.

Particularly with family legacy properties, CIOs often occur over time as original owners die and pass their interests in the legal entity to their heirs. As original owners die and their interests become fractionalized as they pass down to the next generations, it can be very difficult to retroactively pinpoint which transfer resulted in the cumulative transfer of more than 50% ownership interest, and when that specific transfer occurred. Once discovered, it is best to report a CIC or CIO immediately, as penalties and other negative consequences begin to accrue.

Penalties and Escape Assessments.

As we discuss penalties and escape assessments, we will use the following example.

• Example: ABC, Inc. (“ABC”) purchased a parcel of farmland in California in 1970. ABC underwent a CIO in 2013, but this fact was not reported and/or discovered by the local assessor’s office until 2023.

In this example, ABC’s farmland should have been reassessed under Prop 13 in 2013, and the farmland’s property taxes from 2013 onward should been based on its 2013 market value.

Pursuant to California Revenue and Taxation Code Section 463, ABC will be required to pay a penalty of 10% of the assessed value of the unreported taxable property for each of the past years where the new base value went unreported. In other words, in each of those past years ABC did not pay the full amount of the property tax it owed on the farmland, and therefore, each year’s penalty is equal to the amount that is 10% of the taxable assessed value ABC did not pay on in that year.

In addition to the penalties above, ABC’s farmland will be subject to escape assessment and supplemental assessment taxes.

Escape assessments are corrections to a property’s assessed value on the local property tax roll, and pursuant to those corrections, additional property tax bills are sent to the property owner. Using our example, the local county assessor will send a property tax bill to ABC for the total amount of unpaid taxes based off the corrected past values. However, pursuant to Revenue and Taxation Code 532, escape assessments may only be made within 4 years (8 years in limited circumstances) after the assessment year in which the property escaped taxation. Therefore, ABC should only pay escape assessment taxes on the farmland for the 2018-2019, 2019-2020, 2020-2021, and 2021-2022 past tax years.

For the current 2022-2023 tax year, ABC will likely pay a supplemental assessment tax on the farmland. A supplemental tax bill will retroactively tax the supplemental assessment of ABC’s farmland on a pro-rated basis as a result of the assessor’s reassessment of ABC’s farmland during the current tax year.

Factoring in Williamson Act Rules for Agricultural Properties.

For legal entities like ABC, which own farmland or open-space land, the above analysis changes if the farmland or open-space land is subject to a Williamson Act contract.

The California Land Conservation Act of 1965 (“Williamson Act”) enables local governments to enter into contracts with private landowners to provide property tax relief to landowners of farmland and open-space land in exchange for a 10-year agreement that the land will not change use or be developed.

Landowners in Williamson Act contracts enjoy property tax relief because their land is almost always assessed at a rate consistent with its actual agricultural use, rather than potential market value (the “Restricted Value”). Each year, the Restricted Values for lands under Williamson Act contracts are redetermined based on different factors, including but not limited to, what types of crops are being grown on the land that year, and the amount of rent those crops should generate for the landowner. Further, each year the lands under Williamson Act contracts are assessed at the lowest of the following three values:

• The current Restricted Value,
• The current fair market value (“FMV”), or
• The Prop 13 Value, as if unrestricted.

Except in unusual cases, each year the current Restricted Value will be the lowest of the three values for lands under Williamson Act contracts.

Now, let us examine the scenario with ABC, Inc. in the example above, but assume that ABC’s farmland is under a Williamson Act contract.

ABC purchased the farmland in 1970, but pursuant to Prop 13’s implementation in 1978, ABC’s farmland was reassessed using its 1975 value as its base value. In 2023, it was discovered that a CIO occurred within ABC in 2013, and the farmland’s Prop 13 Value is now based its 2013 value. However, pursuant to the Williamson Act rules stated above, if ABC’s farmland was already being assessed based on a lower Restricted Value, the CIO in 2013 may not affect the farmland’s ultimate property tax treatment. This is because if the current Restricted Value may already be lower than the farmland’s Prop 13 Value prior to reassessment, it is also very unlikely that the new Prop 13 Value in 2013 would be is lower than either the original Prop 13 Value based in 1975 or the Restricted Value.

Note however, the Williamson Act rules do not apply to structures and improvements, even if they are on otherwise agricultural land subject to a Williamson Act contract. Therefore, if ABC’s farmland contains a structure, the structure’s value will be affected by the CIO in 2013, and the structure’s base value would be reassessed based on its 2013 Prop 13 Value while the underlying land would continue to be assessed based on its current Restricted Value.

Key Takeaways.

• Transfers of title trigger property reassessments under Prop 13.
• When a property is reassessed, a new base year value for the property is established and is equal to the market value of the property at the time of the triggering event, but future property tax increases are limited to a maximum of 2% per year.
• Properties held by legal entities are deemed to have been transferred when there has been either a CIC or a CIO.
• A CIC occurs when a person or entity obtains more than 50% of the ownership interest in the legal entity.
• A CIO occurs when one or more transfers, results in cumulatively more than 50% of original co-owners’ interest in the legal entity changing hands.
• It is the legal entity’s responsibility to self-report when a change in control or a change in ownership occurs.
• For each year a change in the taxable assessed when unreported there is a penalty of 10% of the taxable assessed value not paid.
• Generally, escape assessments may only be made within 4 years after the assessment year in which a property escaped taxation.
• Restricted Values for lands under Williamson Act contracts are assessed at a rate consistent with its actual agricultural use, rather than potential market value.
• Lands (but not structures) under Williamson Act contracts are assessed at the lowest of the current Restricted Value, FMV, or the Prop 13 Value (as if unrestricted). Restricted Values are generally the lowest of the three values.