Estate planning has many tax implications. Even if you do not have an estate large enough to incur a federal estate tax bill—and that will be most of us—there are other tax issues to consider. For example, what happens to the taxable value of your house if you leave it to your children through a will or trust?
In California, property taxes are based on the assessed value of property rather than its market value. This is generally a good thing if you have owned your home a long time. Say you bought your house in 1995 for $100,000. Under California law, the assessed value may only increase 2% per year. This means the assessed value in 2015 would only be about $145,000. Meanwhile, the market value of the house if you sold it would likely be significantly higher.
When you sell or transfer a house, the assessed value resets for the new owner. So if you sell your house for $500,000, that is the new assessed value. But California law makes an exception when parents sell or transfer their homes to a child. Under this Parent-Child Exclusion, the assessed value does not reset when the child acquires the property. This means if you leave your home to a child in your will or trust, he or she will not have to pay higher property taxes than you did.
Court “Modifies” Trust to Spare Children Higher Property Tax Bill
It is important that your estate plan is clear with respect to transferring real property to a child. Any ambiguity or confusion on this point may lead to unnecessary litigation. Local tax authorities, after all, are not eager to forego additional property tax revenue unless the law demands it.
A recent California appeals court decision illustrates this point. In this case, a man held his residence through a trust co-founded with his late wife. As originally written, the trust provided the house would go the couple’s children after both spouses died. But after his wife’s death, the husband decided to amend the trust to grant his sister—who had moved in the house to help care for him—a life estate in the property. A life estate means the sister could continue to live in the house rent-free after her brother’s death, and when she moved out or died, his children would still inherit the property.
After the man’s death, local tax officials moved to reassess the property—at more than ten times the previous value—arguing the sister was now the beneficial owner of the property. The sister, acting as trustee of her late brother’s trust, asked a probate judge to “modify” the trust to limit her life estate to a maximum of 15 years. This would allow the children to take advantage of the Parent-Child Exclusion, ensuring the property would not be taxed under the higher assessment. The court granted the modification, explaining it clearly reflected the brother’s intentions with respect to his overall estate plan.
It is never a good idea to leave it to a judge to ascertain your wishes after your death. An experienced California estate planning attorney can assist you in ensuring your heirs receive the maximum tax benefits with a minimum of litigation. Contact the Law Office of Scott C. Soady in San Diego today if you would like to speak with an attorney today.