California Property Tax: Change in ownership 01

Change in ownership

One of the most significant increases in property tax that most people will see happens during a change in ownership. It is vital to understand how a change in ownership can affect your property taxes.

The California Legislature defined change in ownership as “a transfer of a present interest in real property including the beneficial use thereof the value of which is substantially equal to the value of the fee interest.”

Identifying a change in ownership is simple and easy when a piece of real property is directly sold from one individual to another, or from one entity (such as a corporation) to another. However, the transaction of change in ownership is not that simple and straightforward in all cases; it may involve partial ownership interest in a single piece of real property, and other complex transaction among individuals, trusts, and corporations, etc. For example, the transfer of ownership interests in a legal entity like corporation may have effect of a ‘‘change in ownership’’ of the corporation’s underlying real property.

It is important to note that the change in ownership is different for the purpose of Property Taxes than the change of ownership for obtaining title of real property. Be aware that:

Transfers of real property do not necessarily result in a change in ownership of the real property, and it is possible for a change in ownership to occur without transfer of title to the real property.

Irrespective of its treatment in Property Tax law, a transfer of property may be a voluntary or involuntary transfer. It may take place by operation of law or may be a result of:

    1. A purchase or sale whether recorded or not;
2. A grant;
3. A gift, i.e. a real property given willingly to someone without payment;
4. Devise through inheritance or through a trust;
5. An addition of an owner to the existing the owners of a real property;
6. A deletion of the existing owners of a real property; or
Property settlement.

A transfer of a real property may take place with or without consideration. Consideration is something of value, e.g. another real property that may be exchanged for the property. Other examples of consideration include money, the assumption of a debt, the cancellation of an outstanding debt, the creation of a debt, etc.

Illustration

Identify transfer of real property in the following cases:

1. Ms. Samantha sold her house to Mr. Ethan Alexander for $ 150,000 in cash;

2. Mr. Julian Jacob gifted his farm house worth $ 345,000 to his wife Olivia; and

3. Sophia transferred her house to her daughter Chloe through a sales deed.

The sale of house from Ms. Samantha to Mr. Ethan Alexander for $150,000 in cash is a transfer. It is also a change in ownership, and it is not an exclusion. Therefore, it will trigger reassessment of the property.

The gift of farm house from Mr. Julian Jacob to his wife Olivia is a transfer. It is a change in ownership, but it is an exclusion namely, Inter-spousal transfer. It will not trigger reassessment of the farm house.

The transfer of the house from Sophia to her daughter Chloe through a sales deed is a transfer and change in ownership. It is a change in ownership, but it is an exclusion namely, parent child transfer. It will not trigger reassessment of the house.

How change in ownership can increase Property Tax Bills

A Country Assessor assesses Assessed Value of your property at Base Year Value of 1975, and does not change it without any cogent reason. The cogent reasons to change the Assessed Value of your property include all the bases of changing the Assessed Value of your property provided by the Revenue & Taxation Code. Three common reasons to change the value of your property are new construction, inflation, and change in ownership.

Property Tax Liability	=	Assessed Value	X	Rate of Tax
­ ­ Change in ownership affects this Assessed Value to change your Property Tax Liability

In the simple equation shown above, the relationship between change in ownership and Assessed Value is the most important point and is the subject matter of this eBook. The effect of a change in ownership is such as it may create a wide gap between Assessed Values of two strikingly similar properties. The fact is explained in the coming paragraph and illustration.

Changes in ownership create disparities in Assessed Value and result in different tax liability for owners who own similar properties. They, despite owning similar properties, can have substantially different Assessed Values based solely on the dates the properties were purchased. These disparities result in locations and in counties wherever significant appreciation in property values has occurred over time. Longtime owners of property who’s Assessed Values generally may not be increased more than 2 percent per year, gets the benefits of holding the properties. They tend to have noticeably lower tax liability than that of recent purchasers of similar properties. The clear reason behind higher tax liability of recent purchases of the properties in that the Assessed Values of their properties tend to approximate market levels.

Illustration

Mr. Allan Anderson owns a house adjacent to that of Mrs. Wallis Watson, his neighbor. Both the houses are similar and the County Assessor has assessed them at $ 121,000 each for the year 2012-13. Mrs. Wallis Watson sold her house to Mrs. Sara Smith. What will be the difference between the Property Tax Liabilities of Mr. Allan Anderson and his old and new neighbor? The property owners in the county pay 1.0% tax on average and the current market price of the house sold is $351,000.

Property Tax before change in ownership

Mr. Allan Anderson’s house has Assessed Value $121,000. If you ignore any adjustment for inflation, you can calculate the Property Tax for year 2013-14 as under:

Property Tax Liability	=	Assessed Value	X	Rate of Tax
$1,210	=	$121,000	X	1.0%

Before transfer, Mrs. Wallis Watson’s house has Assessed Value $121,000. If you ignore any adjustment for inflation, you can calculate the Property Tax for year 2013-14 as under:

Property Tax Liability	=	Assessed Value	X	Rate of Tax
$1,210	=	$121,000	X	1.0%

Property Tax after change in ownership

Since, there is no change in ownership, Mr. Allan Anderson’s house has the same Assessed Value i.e. $121,000. If you ignore any adjustment for inflation, you can calculate the Property Tax for year 2013-14 as under:

Property Tax Liability	=	Assessed Value	X	Rate of Tax
$1,210	=	$121,000	X	1.0%

After transfer, Mrs. Sara Smith’s house has Assessed Value $351,000. If you ignore any adjustment for inflation, you can calculate the Property Tax for year 2013-14 as under:

Property Tax Liability	=	Assessed Value	X	Rate of Tax
$3,510	=	$351,000	X	1.0%

The Property Tax Liabilities of Mr. Allan Anderson and his neighbor Mrs. Wallis Watson is same i.e. $1,210. However, because of change in ownership Mrs. Sara Smith has to pay Property Tax more than the Property Tax to be paid by Mr. Allan Anderson. Mr. Allan Anderson will pay ONLY $1,210, but Mrs. Sara Smith will pay $3,510 just because of the change in ownership. A difference of $ 2300 in tax payable!

As mentioned above, there are a number of exclusions to reassessment during changes in ownership. These will be examined in detail in a future post.

California Property Tax: Change in ownership and Proposition 13

Property Tax in California 

If you own taxable property on January 1, you become an assessee and are liable to pay property tax. The property tax amount you have to pay is based on the value of your property, or more accurately on its assessed value. The assessed value of your property is the value determined by the County Assessor of your county for property tax purposes. It is shown on your property tax bill (see a typical property tax bill below). The assessed value of your property is likely to be the prior year’s assessed value adjusted for inflation by up to 2%. Hence, you normally do not expect a large increase in your property tax bill. You will receive a property tax bill with a normal increase in amount payable unless there is a change in ownership.

If there has been a change in ownership of your property, its assessed value no longer remains the prior year’s assessed value adjusted for inflation. Its new assessed value will be its market value after it has changed ownership. The date of change in ownership is also important to ascertain the effective year of change in assessed value. Since, your property tax is calculated on the assessed value of your property, the change in ownership and its effective date can have a major impact on your property tax bill.

This section will explain to you the two primary factors that affect your property tax bill, as well as how change in ownership can be another dominant factor that results into higher assessed values and property tax bills.

A property tax bill gives you important information including the name of the owner, assessed value of the property, and property tax rate.

Property Tax Bill

Two primary factors which increase your Property Tax Bill

Your Property Tax on real property depends on two primary factors:

1. The taxable value (assessed value) of your real property; and
2. The tax rate.

One of the other factors that affects your property tax liability is change in ownership. It is a dominant factor which increases your property tax by increasing the assessed value of your property. As the assessed value increases, it causes your property tax to increase as a result. 

When a change in ownership occurs, the County Assessor assigns a new assessed value to your property. The technical term for assigning a new taxable value to your property is reappraisal or reassessment. 

In California, reassessment based on change in ownership can very often account for major increases in property taxes each year. The reappraisal or reassessment of property due to change in ownership is one of the major driving forces behind higher property tax bills and increases in public revenue.

Let us examine how property taxes are calculated and how the changes in ownership increases the payable amount shown on a property tax bill. It is important to keep three items in focus throughout the coming text. The three factors are assessed value and increases in it; rate of property tax, and change in ownership.

You cannot calculate property tax without assigning a value to your property

You cannot calculate the annual property tax on your real property simply by punching the number of rooms, shops, apartments, and swimming pools into a calculator! You need to know the value that has been assigned to your specific property. Once you know this value, the process of calculating your property tax liability is simple and straightforward. You need to multiply the value by the tax rate to get the amount of property tax payable. That is:

Property tax = property value X tax rate

The value on which you calculate the property tax of your real property is the first primary factor that affects amount payable shown on your property tax bill. A county assessor will call it the assessed value (taxable value) of your property, i.e., the value on which your property tax liability is computed. The higher the value of your property, the higher will be your property tax bill. That is why owners of properties strive to keep the assessed value of their properties by adopting all possible legal measures.

The California Revenue and Taxation Code and Property Tax Rules spells out a precise procedure to determine this assessed value of your real property based on its size, location, improvements (houses, garages, fences, etc.), and other factors.

Note the underlying arithmetic:

The higher the assessed value of your property, the higher the tax liability on your real property will be.

The County Assessor may increase the assessed value of your property each year in order to adjust for inflation.

In summary, the assessed value of your property will be reappraised by the County Assessor based on any new construction, as well as change in ownership. It will also be adjusted for inflation in addition to any reappraisal.

You need a rate to calculate property tax on the value of your property.

The assessed value of your real property is not sufficient alone to determine your property tax liability. You also need a property tax rate to multiply by this value to determine property tax payable. The rate of property tax is the second primary factors which increases or decreases your property tax in a given year.

Arithmetic is simple:

The higher the rate of property tax rate in your county, the higher your tax liability will be.

A lower tax rate is good for saving property owners money and a higher tax rate is good for tax collectors.

The power to tax

This Article is about locally assessed real property. Locally assessed personal property and state-assessed properties are not subject of this Article/eBook.

The local government has power to tax real property. Primarily, the government exercises the power to tax by imposing tax at specified rates and subsequently changing the rate of tax annually or after a suitable period.

The government increases tax by increasing assessed value and rate of property tax

Because the amount of your property tax bill depends on the assessed value of your property, it changes as the assessed value of your property changes. In addition, if rate of tax changes, your property tax also changes. Therefore, in addition to other measures, the government can increase property tax amount on property by changing both the primary factors which determine your property tax.

The government can increase your property tax by:

1. Increasing the assessed value of property; and
2. Increasing the property tax rate.

Prior to 1978, annual assessments for real property were based on current fair market value. In addition, it was not possible for the County Assessors to annually assess property due to financial and human resource constraints. Therefore, they assessed property on a cyclical basis after every three to five years. Between these reappraisal cycles, county assessors would often apply interim value increases based on trending factors such as inflation.

If the County Assessor of your county uses the market value as the assessed value of your property, your property tax bill will increase or decrease with the changes in the market value of your property. In turn, the market value of your property changes based on the market forces that drive the real estate market. Therefore, the tax on your real property is subject to both market forces and the government. If real estate prices are soaring, property tax bills will also show higher payable amounts. Before 1978, the government was on the receiving side of these benefits because of ever-increasing real estate prices. However, the assessed value was no longer allowed to increase based on market values of property after 1978.

Prior to 1978, there were no prescribed limits on assessing initial assessed value at a base year values, increasing the assessed value from year to year, or increasing the rate of property tax. The passage of Proposition 13 in 1978 prescribed these limits and curtailed many of the methods of the government to tax real properties.

Proposition 13 has limited the government’s power to tax

In June 1978, California voters approved Proposition 13 to change property taxation in California. The passage of Proposition 13:

1. Limited the property tax rate applied to assessed values to 1 percent plus additional rates to retire bonded indebtedness;
2. Placed explicit limitations on the power of the government to impose additional property taxes; and
3. Limited increases in assessed values.

Proposition 13 limited the power of the government to assign values to properties by fixing base values for properties at market values of 1975 in general. After its passage in 1978, the assessment procedure of real properties for property tax has dramatically changed. Real property values for property tax purposes are now rolled back to their March 1, 1975, values before any increase in them and before calculating property tax on these values.

In addition to fixing the base values, Proposition 13 further limited the government’s power to tax by placing strict upper limits on annual increases in assessed values. The assessed value of a property cannot increase by more than 2% in any given year. This means both the initial assessment of a property and its yearly increase are now limited.

After Proposition 13, a County Assessor annually assesses all real property in California annually on January 1. Under the Revenue & Taxation Code, two values are compared, and the greater of the two is assigned as the assessed value for the property:

1. Base Year Value as of March 1, 1975 plus adjustment for inflation; and
2. Base Year Value as of the date of recent change in ownership.

Base Year Value as of the date of new construction is also relevant because new construction also triggers reassessment. However, reassessment based on new construction is beyond the scope of this article/eBook.

Thus, Base Year Value of March 1, 1975 plus adjustment will be the assessed value of your property unless there is new construction on your property, or the property is transferred through sale. Therefore, any new construction or transfer is likely to result in a higher assessed values for your property.

A base year value is the full cash value or fair market value of the property. The base year value is adjusted for inflation at a specified rate. Since Proposition 13 placed a limit on the annual increase in assessed value, the base year value cannot be increased by more than 2% in a year, unless the property is transferred or new construction takes place.

The law defines fair market value as the full cash value of real property or its equivalent. It is the amount of cash that the seller of the real property would expect to receive on the open market if neither party were under an exigency to enter into the transaction and both parties were fully informed about any advantages or disadvantage associated with the property.

After the passage of Proposition 13, the value of real property in California, for property tax purposes, does not necessarily increase to keep pace with its current fair market value. However, a change in ownership can result in the assessed value being increased to the current market value, regardless of its previous assessed value.