Forms of Ownership: Entity Ownership

A legal entity is an artificial legal person and it has legal capacity like an individual. It can:

1. Enter into agreements or contracts;
2. Assume obligations;
3. Incur and pay debts and loans;
4. Sue others and can be sued;
5. Be held responsible for its actions; and
6. Contract for purchase, sale, or lease of real property.
Just like a real person, a legal entity’s interests in real property may be owned individually, owned by another legal entity, or held in trust. Some of the most common examples of legal entities holding title to real property in California are:

1. Corporations,
2. Partnerships,
3. Limited liability companies,
4. Joint ventures,
5. Massachusetts business trusts, and
6. Real estate investment trusts.

Change in ownership for legal entities

In general, transfers of corporate voting stock, partnership ownership interests, LLC membership interests, or ownership interests in other legal entities are not changes in ownership of the real property owned by the entity.

The above general rule does not apply to three exceptions:

1. A transfer of an ownership interest in a legal entity that shifts control of the entity;
2. A transfer of an ownership interest in a legal entity by an original co-owner resulting into a cumulative transfer of more than 50 percent of all the interests held by original co-owners; and
3. A transfer of shares in a cooperative housing corporation.
In general, there are two types of transfers involving legal entities that result in a change in ownership for the purpose of Property Tax in California:

1. The transfer of interest in real property to and by a legal entity; and
2. The transfer of ownership interest in a legal entity that owns real property.
The first type of transfer involves a transfer of an interest in real property between legal entities i.e. between a corporation, partnership, LLC, or other entity, etc. The transfers also include transfers between a legal entity and its shareholders.
The second type of transfer involves transfer of ownership interest in a legal entity. The real property is in ownership of the legal entity before and after this type of transfer. Only the ownership interests of the legal entity change.

Both type of transfers trigger a change in ownership of the real property owned by the legal entity. Therefore, the property held by the legal entity attracts reassessment based of change in ownership.

Illustration

Mr. Arthur Andrews, Mrs. Ava Andrews, and their daughter Ashley Andrews owns 51%, 39% and 10% shares in a legal entity. The legal entity owns a real property worth $660,000. Who owns the legal entity? Who controls it? Who owns the real property? And who controls the real property? 

What should Mr. Andrews do if he wants to shift the control of the property to his wife, Ava?

The situation is best explained using a diagram:

Diagram 01

Mr. Andrew Arthur 51% Shares Mrs. Ava Andrew 39% Shares Miss Ashley Andrew 10% Shares	----	Family of Mr. Andrew Arthur owns the legal entity.
­ I
Ownership of legal entity
­ I
Legal Entity	----	The legal entity owns the real property
­ I
Ownership of Real property
­ I
Real Property	----	The real property to be assessed for Property Tax.

Arthur Andrews, his wife, and his daughter owns the legal entity as shown in the diagram. However, effective control on the administration of the legal entity requires ownership of more than 50% share. Therefore, Mr. Andrews controls the legal entity; he has 51% shares in ownership of the entity.

If Mr. Andrews wants to shift the control of real property to his wife, Ava, he will have to transfer 12% or more of his shares in the legal entity to her. Mrs. Andrews will have more than 50% shares in the legal entity then and she will effectively control the property owned by the legal entity. In such transfers of control as transfer of ownership of a legal entity, there is no change of ownership of a real property in strict sense of such a change. However, effective control of the real property changes hands from one person to another, namely from Arthur Andrews to his wife Ava Andrews.
The legal entity owns the real property, but it has its own owner controlling it – Mr. Andrews. Thus, Mr. Andrews controls the property without having a direct ownership of the property.

The county assessor understands this possibility of control through legal entity. The Revenue and Taxation Code allows the county assessor to treat this type of indirect control and its transfer as ownership and change in ownership respectively.

Illustration

Zara owns 60% of the voting stock of the Asian Logistics Corporation. The Asian Logistics Corporation owns three warehouse in California worth $3.0 Million, $3.2 Million and $2.0 Million. The current fair market value of these warehouses is about ten times more than the acquired values of the warehouses in 2007. Zara wants to leave the country after selling voting stock to her husband, Smith, and one of her business fellow, Nathan. Nathan and Smith already have 30% and 10% voting stock of the corporation. Which of the following options will not trigger reassessment of the underlying property of the corporation: 

1. Zara transfers 60% voting stock to Nathan?
2. She transfers voting stock to Smith and Nathan 30% each?
3. She transfers 45% voting stock to Smith and 15% to Nathan?

In option 1, the control of the corporation will be transferred to Nathan and the warehouses owned by the corporation will be reappraised. Since, the fair market values of these warehouses are about ten times larger than there acquisition values in 2007, Property Tax increase will also be huge.

The Option 2 will also produce the same results.
In Option 3, the control of the corporation will be transferred to Smith, her spouse, the change in ownership will qualify for inter-spousal transfer exclusion.

Illustration

Three brothers, Joseph, Jose, and Jeremy created a partnership for starting a retail store in a rented building. Subsequently, the partnership purchased the store’s land and building. Joseph owns 51%, Jose owns 48%, and Jeremy owns 1% of the partnership. The partnership has a continuing clause so that the partnership does not terminate if any of the brothers dies. 

After two years, Joseph died in an accident. Upon death, his will gave 10% interest to his brother Jose, and 41% interest to his son David. 

Will the property owned by the partnership be reappraised by the County Assessor?

The control of the partnership has shifted from Joseph to Jose. This change in control is sufficient to constitute a change in ownership and to trigger reassessment of the underlying land and building of the store by the County Assessor.