By Alma Soongi Beck, J.D. LL.M. Taxation, California State Bar Certified Specialist in Estate Planning, Trust and Probate Law
With so much attention on the marriage cases, practitioners advising same-sex couples may be missing two crucial changes in property tax rules from 2013 affecting co-owners of property who are not married to each other or registered in the state as domestic partners.
The issue is Property Tax Reassessment, which has often been bad news for same-sex couples. California state property taxes have been governed by Proposition 13 since 1978, which in most cases sets property taxes based on the acquisition value, increasing the taxes only 2% a year until the property undergoes a “Change of Ownership.” Upon Change of Ownership (e.g. sale), the new owners are “Reassessed” based on the current market value. This means that when the property has appreciated faster than 2% a year, “Reassessment” can result in a huge increase in the property taxes, depending on how large the increase.
Change in Ownership also occurs at death, which is where same-sex couples have been burned in the past. In fact, Reassessment can be one of the most serious issues for same-sex couples who inherit real property from each other. Reassessment can result in such a large increase in the property tax that the surviving partner can no longer afford to keep the home.
Thankfully, Exemptions from Reassessment were extended to state-registered domestic partners (SRDPs) in 2006 under SB 565, and to same-sex married couples in 2008 when same-sex marriages were recognized and then upheld.
However, for couples who are not married or registered as SRDPs , the issue of possible future Reassessment still looms. In these situations, two options to avoid Reassessment are still available:
A. 2013 Cotenancy Rule, AB 1700 (effective January 2013)
Under AB1700, which amended Section 62.3 of the Revenue and Taxation Code, a surviving co-owner can avoid Reassessment if all of the following conditions are met:
- Only two owners (or “cotenants”) had owned the property before death, and together they had owned 100% of the property either as joint tenants or tenants in common.
- Both cotenants had lived in the property as primary residence for at least one year prior to the death of an owner.
- Transfer of property is due to death of an owner, and after transfer, the remaining cotenant owns 100% of the property.
- The remaining cotenant signs an affidavit proving that he/she consistently lived in the property as primary residence at least one-year prior to death of the first owner.
B. 2003 Joint Tenancy Transfer Rule 462.040 – partly expired October 2013
While AB1700 will help many same-sex couples who are not married or SRDPs, for those cases not addressed by AB1700, the 2003 Joint Tenancy Transfer Rule might be the only other option for same-sex couples to avoid Reassessment upon death of a co-owner (other than getting married or registering as SRDPs).
Rule 462.040 was expanded in October 2003 in a way that allowed unmarried and same-sex couples the ability to avoid Reassessment upon death of a co-owner for the first time ever in California history. Specifically, in 2003, 462.040 was expanded to allow two additional ways to qualify for Exemption: (A) transfer from co-owners as non joint tenants (e.g., tenancy in common) to joint tenancy; and (B) transfer from joint tenancy into trusts (e.g., revocable trusts) where the other owner is named as beneficiary of the property upon death.
When couples properly understand the rule (usually upon consultation with legal counsel), they can qualify for Part A directly upon acquisition of a new property. Specifically, they can acquire the property as tenants in common and then immediately transfer to themselves as joint tenancy.
In many cases, however, Part A is not possible, such as when the property is already in Joint Tenancy. In fact, most couples are still completely unaware of the 2003 rule expansion, as are many of their realtors, mortgage brokers, title officers, and in some cases, their legal counsel. In these cases, the opportunity to qualify for Part A can be easily missed upon purchase of a new property.
So basically, on the one hand, the passage of AB 1700 is great news for same-sex couples who co-own primary residences, with no other people other than themselves. But, on the other hand, the repeal of Part B of 462.040 now severely limits options for other same-sex couples whose situation falls outside the scope of AB1700.
People who are most affected include:
- Couples who own real property that is not a primary residence for one or both;
- Couples who own with other people, even if it is their primary residence (e.g., “tenancy-in-common” ownership of multi-unit buildings);
- Couples who have owned real property for less than one year, where one person may be terminal and possibly passing away before the one year mark;
- Couples who may have relied on Part B in previous years, and who removed the property from Trust (e.g., during a refinance), but may not have put it back.
For these situations, and given that the October 1, 2013 partial repeal of Rule 462.040 has already occurred, practitioners may want to offer the following considerations:
(1) Property tax protection is still available for transfers between married couples and California state domestic partners. If your clients missed their opportunity to qualify for the now-repealed rule, they may want to re-think your decision regarding marriage or state domestic partnership.
IMPORTANT NOTE: While marriage and California state domestic partnership both bring with them tremendous advantages under state and (for marriage, now federal) laws, there are some situations where either or both are not a good idea for a couple. In some instances, the reasons are as simple as not wanting to be “out” about your relationship in the workplace due to concerns about discrimination. In other cases, the reasons are financial or tax-based, such as the impact on federal or state income taxes, or the impact on qualifying for state Medicaid (or in California, Medi-Cal) in the event skilled nursing care is needed.
(2) If your clients decide not to marry or register as state domestic partners, and they have already done a transfer from Joint Tenancy into Trust (where the Trusts each name the other owner as beneficiary upon death), and that transfer was done prior to October 1, 2013, they can still qualify for Rule 462.040 protection if they never take their property out of their Trusts, even for refinance purposes.
If any of your clients are relying on Part B of Rule 462.040 for future property tax protection, the repeal of this part of the Rule requires extra vigilance to make sure the property is never removed from the Trusts. This situation could arise unexpectedly such as:
- During estate planning, if you assist your clients to set up new trusts instead of amending and repealing their current trusts;
- During refinance, if the clients’ lender or title officer says, sometimes casually or at the very last minute, that they can “just take the property out of the trust and put it back.”
(3) If your clients decide not to marry or register as state domestic partners, and they have previously already transferred from Tenancy in Common to Joint Tenancy (with the exact same co-owners), they still qualify for the part of Rule 462.040 that was not repealed and that is still on the books. However, if they then do a subsequent transfer from Joint Tenancy into Trust and that transfer was done October 1, 2013 or later, they will then disqualify themselves from property tax protection under this rule.
The problem with this result is that it is counter-intuitive. The exact thing that used to bring more protection before October 1, 2013, is not the very thing that eliminates the clients’ protection now.
This situation would most commonly arise during estate planning, such as when a practitioner suggests that the couple set up revocable living trusts, and then suggests to transfer the real property into the trusts.
Such advice is understandable for practitioners, who have historically disfavored joint tenancy for nonmarried, non-domestic partners has for several reasons, such as the double counting of joint tenancy property under Internal Revenue Code 2040, or the lack of control over who inherits after the second co-owner dies, or the probate risk upon the second death.
However, now that Part B of Rule 462.040 has been repealed, these factors have to be weighed against the potential impact of the increase in the Property Taxes. The potential increase can be massive, depending on how much the Property has appreciated beyond its current assessed value.
For these reasons, practitioners will want to assist our clients in this situation regarding the pros and cons of each option. This could also be an important opportunity to help our clients revisit the option of marrying and/or registering as California state domestic partners.