A buyer as the high bidder at a trustee’s foreclosure sale purchases a parcel of real estate. To determine the base year value of the property for reassessment on a change of ownership, the County Assessor uses the comparable sales analysis approach to calculate its fair market value (FMV). The price paid at the trustee’s sale is disregarded by the County Assessor as it is measurably lower than the FMV determined by the comparable sales approach.
The buyer seeks to have the base year value assessment for the property set at the price they paid to purchase the property at the trustee’s sale. The buyer claims the value determined by the County Assessor failed to apply the statutory presumption that the purchase price paid by a buyer for a property presumptively establishes the property’s fair market value (FMV).
The County Assessor claims the presumption of full cash value for prices paid by a buyer for a property does not apply to trustee’s foreclosure sales since trustee’s sales are:
- sales forced by a creditor;
- devoid of arms-length negotiations between the owner and a buyer; and
- non-open market transactions.
Does the purchase price paid by the highest bidder at a trustee’s foreclosure sale establish a property’s fair market value for setting the property’s new base year value assessment on a change in ownership?
No! The fair value presumption for establishing a property’s value does not apply to purchases at a trustee’s foreclosure sale. Trustee’s sales are not open market transactions, a precondition to applying the fair value presumption. [Phillis v. County of Humboldt (December 31, 2020) _CA6th_]
The terminology of assessments for property taxes
A base year value is the initial assessment set by the County Assessor on a change of ownership as the amount of the FMV of a property on the date a new owner acquires it. A base year value is established for every property on a transfer classified as a change of ownership, whether or not the new owner qualifies for an exemption or exclusion to determine the annual taxable value used by the County Tax Collector to set property taxes.
Taxable value is the annual valuation of property set by the County Assessor for use by the County Tax Collector to levy annual property taxes. Taxable value is commonly referred to as the assessed taxable value or current taxable value for a property.
The factored base year value for a property is the base year value adjusted upward annually by the County Assessor to reflect consumer inflation limited to 2% annually, compounded. The annual adjusted base year value, without application of exemptions or exclusions, sets the taxable value used by the County Tax Collector to calculate property taxes owed for the current fiscal year.
A property’s assessed taxable value for the first year of a new ownership is the amount of the property’s base year value, the FMV generally set as the price paid for the property. After the first year of ownership, both the base year value and the assessed taxable value are increased annually at the rate of consumer inflation, capped at 2% over the prior year’s assessed taxable value.
When exempt or excluded amounts of the base year value (FMV) qualify to reduce the assessed taxable value below the base year value, the annual inflation adjustment is made to both the base line value and the assessed taxable value. Again, property taxes are calculated on the assessed taxable value.
The adjusted base year value, called the factored base year value assessment, is used to set the amount of property taxes due for owning the property when the ownership does not or no longer qualifies for exemptions or exclusions from the base year value.
Prop 19 exclusions set the assessed taxable value
Owners of their primary residence who are aged 55 or more, or are severely disabled individuals, may transfer the amount of the current adjusted assessed taxable value of their primary residence to a replacement residence anywhere in the state. This right to carry forward the amount of the assessed taxable value of the residence sold to become the base-year value for the replacement residence is:
- limited in time to the purchase of the replacement residence within two years before or after the closing date on the sale of their residence, a four-year window period; and
- the assessed taxable value for the portion of the price paid for the replacement residence equal or less than the price received for the residence sold. [Prop 19 in 2021]
This transfer of the assessed taxable value amount to a replacement residence is also available to disaster and wildfire victims without concern for their age when their primary residence is substantially damaged.
When the FMV of a replacement residence is equal to or less than the FMV price received for the primary residence the homeowner sold, the new base year value assessment for the replacement residence is set as the amount of the current assessed taxable value of the residence they sold.
For example, consider a homeowner who has a factored (inflation-adjusted) base year value of $300,000. This figure is also the amount of the property’s assessed taxable value used by the Tax Collector to levy property taxes during the fiscal year of its sale. The residence sold for $550,000, its FMV. The owner then purchases a replacement primary residence for $500,000.
Since the FMV of the replacement residence ($500,000) is equal or less than the FMV of the residence they sold ($550,000), the new base year value assessment set for the replacement residence is $300,000. This figure also becomes the assessed taxable value for determining the amount of property taxes during the first fiscal year owning the replacement property.
On the other hand, when the price paid for their replacement residence is greater than the sales price they received for their primary residence, the new base year value of the replacement residence, and in turn its first year’s assessed taxable value, is the sum of:
- the current factored base year value carried forward from the home they sold; plus
- the excess amount of the price paid for the replacement residence over the price received for the residence they sold.
For example, consider a homeowner’s primary residence which has an adjusted base year value of $300,000. The owner sells the residence for $550,000. Within two years before or after the sale of their residence, the owner purchases (or completes construction of) a replacement residence for $600,000.
Here, the price paid for the owner’s replacement residence ($600,000) is greater by $50,000 than the price received for the residence they sold ($550,000).
Here, the new base year value assessment – and the taxable value for levying property taxes – of the replacement residence is $350,000, determined as the sum of:
- $300,000, the adjusted base year value assessment transferred from the residence sold; plus
- $50,000, the excess in the price paid for the replacement property over the price received for the residence they sold ($550,000).
Fair market value and assessment
The fair market value (FMV)
Thus, FMV is determined by the price a buyer willingly pays for a property when negotiating a purchase in a standard, open market transaction, which includes an agent. After the transaction takes place, the property’s base year value assessment and assessed taxable value are set by the County Assessor. Based on the taxable value, not the base year value, the County Tax Collector calculates and levies property taxes, also called ad valorem taxes.
However, when property is purchased in a non-open market transaction, the purchase price paid for a property might not be an accurate representation of its FMV. [Calif. Revenue and Taxation Code §110(b)]
Non-open market transactions include foreclosure sales. These auction sales require specific, state-prescribed conditions controlling advertising and the time and manner for conducting a creditor’s forced sale by a trustee of the secured property on a default by the owner.
The nonjudicial foreclosure process has three stages:
- the notice of default (NOD) is recorded and mailed;
- the notice of trustee’s sale (NOTS) is recorded, posted and mailed; and
- the trustee’s sale of the real estate by auction, followed by the execution of the trustee’s deed and distribution of sales proceeds.
Three months after the NOD is recorded to commence the foreclosure process, the trustee may notice the date set for the sale of the property described in the trust deed lien being foreclosed. [Calif. Civil Code §2924]
At least 20 calendar days before the trustee’s sale, the trustee sends two copies of the NOTS to each party the trustee previously sent the NOD, one certified and the other regular mail. [CC §2924b(c)(3)]
The trustee’s sale is held in the county where the secured real estate is located. [CC §29249(a)]
Once the trustee’s sale is completed, the trustor has no further rights of redemption to satisfy the money obligation owed and recovery ownership of the property. [Melendrez v. D&I Investment, Inc. (2005) 127 CA4th 1238]
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A reasonably equivalent value as the foreclosure price
As legislated procedures for foreclosure sales instruct trustees to follow specific steps, property auctioned for sale under these narrow conditions are simply worth less. Worse, rarely are disclosures made about the conditions affecting the physical property and a policy of title insurance is not available to assure the buyer they have purchased good title to the property or just what encumbrances affect that title.
Buyers do not pay as much for a property sold under distressed circumstances compared to a property sold at leisure and pursuant to normal marketing techniques, assurances, and procedures. As a trustee’s foreclosure avoids all the typical marketing activities, the property is exposed to and sought out by far fewer potential buyers and pricing is more likely to be suppressed by implicit collusion or chill-bidding arrangements. Thus, FMV cannot be determined based on a price paid in the forced-sale context.
For trustee’s foreclosure sales, a reasonably equivalent value standard is applied to the price paid by the highest bidder. The reasonably equivalent value theory considers the price paid by the highest bidder – the successful buyer at the trustee’s sale auction – to be a sufficient price for the property at a properly noticed and managed trustee’s sale. It is a presumption that the value of a property sold under conditions of an auction at a foreclosure sale is the price paid by the highest bidder. [BFP v. Resolution Trust Corp. (1994) 511 US 531]
Consider a property owner who defaults on their mortgage payments. The property subject to the trust deed (mortgage) lien is sold by a trustee through a properly noticed nonjudicial foreclosure sale to a buyer – the highest bidder. The purchase price paid at the trustee’s sale is far less than the amount the wiped-out owner claims their property is worth in the open market.
The now wiped-out owner seeks to set aside the trustee’s deed conveying the property to the buyer claiming the nonjudicial foreclosure sale constituted a fraudulent transfer since the property was worth a substantially higher amount than the sale price paid by the highest bidder and thus was not sold – exchanged – for a reasonably equivalent value.
The buyer defending their title to ownership under the trustee’s deed claims the conveyance was not a fraudulent transfer since the foreclosure sale was conducted in compliance with state law controlling the critical aspects of a trustee’s nonjudicial foreclosure sale and the price paid was neither collusive nor fraudulent.
Is the price paid at the nonjudicial foreclosure sale the reasonably equivalent value for the property?
Yes! Here, the price received at the nonjudicial foreclosure sale is the reasonably equivalent value since all requirements of the state’s foreclosure law were met. [BFP, supra]
Mortgage lenders facing a loss as FMV drops
With foreclosure sales, the foreclosing creditor – typically a mortgage lender – is not attempting to maximize the equity an owner might capture for a property sold in an open market transaction. Rather, the lender is attempting to recoup the balance due on a mortgage that is in default when the property owner is unwilling or unable to satisfy the debt – pay – prior to completion of the trustee’s sale.
Additionally, the foreclosing lender receives no part of any surplus funds the trustee receives from the highest bidder on the foreclosure sale over the amount of the secured debt owed the lender and out-of-pocket costs of foreclosure. [CC §2924k]
Ultimately, a foreclosure sale is a mechanism for a lender to mitigate its losses, not for a distressed property owner to obtain the highest and best price for their property.
Now consider a lender who originates a mortgage with a buyer to fund their purchase of several properties. The mortgage note is secured by a trust deed lien on all properties acquired. The lender funds the mortgage origination based on misrepresentations of FMV by their agents acting as mortgage loan brokers and appraisers.
The buyer defaults on the mortgage and the lender initiates a trustee’s foreclosure under the power-of-sale provision in the trust deed. The lender purchases the properties as the highest bidder at the trustee’s sale by bidding the full amount of their credit value under the outstanding debt – an exchange of debt for property. The property’s FMV is measurably less than the amount bid.
Does the lender’s purchase of property by a full credit bid at a trustee’s foreclosure sale bar the lender from maintaining a fraud action to recover their actual money loss on the mortgages from agents and appraisers who fraudulently induced the lender to fund the mortgages?
No! A full credit bid does not establish the value of the property at the foreclosure sale by the reasonably equivalent value presumption for all purposes, but only for the purpose of foreclosure proceedings against a borrower. Since the bidder (the lender) was fraudulently induced to make a full credit bid by being intentionally and materially misled by its own agents, the lender is able to recover its losses from the agents, but not the borrower who is shielded by anti-deficiency laws. [Alliance Mortgage Co. v. Rothwell (1995) 10 CA4d 1226]
No FMV recovery for a wiped-out owner
Consider another scenario of a property owner who defaults on their mortgage. The secured property is sold at a trustee’s sale. The owner seeks to set aside the trustee’s sale and cancel the trustee’s deed claiming the buyer of the property at the trustee’s sale is not a bona fide purchaser (BFP). The buyer is experienced in foreclosure sales and knowingly paid less than the FMV of the property.
The buyer claims they are a BFP of the property since they paid value for the property without notice of any adverse interest or of any irregularity in the trustee’s foreclosure sale proceedings.
Is the trustee’s deed transferring property to the buyer as high bidder at the trustee’s sale valid when the price paid is known to a sophisticated buyer to be less than the FMV of the property?
Yes! The buyer qualifies as a BFP of the property at the trustee’s sale. The buyer paid cash as the high bidder and had no notice of any other party’s claim to the title of the property, regardless that the price paid was less than its FMV. [Melendrez, supra]
Further non-open market transactions
In addition to foreclosure sales, other related non-market transactions in which the FMV is not accurately reflected by the purchase price include:
- a short sale; and
- a deed-in-lieu of foreclosure.
Short sales
Short sales, also known as short payoffs or discounted payoffs, are initiated during a real estate market crash. Here, the property owner commences negotiations with the mortgage lender to cancel a portion of the mortgage debt, rather than the lender acting against the owner to collect the debt as occurs in a foreclosure.
When a short sale cannot be arranged with a buyer, the homeowner’s alternative is to negotiate a deed-in-lieu sale to the mortgage holder. This transaction delivering title to the lender is a last resort for a lender to salvage their investment in a mortgage, agreed to when:
- the mortgage balance encumbering the property is greater than the property’s sales value;
- the mortgage is a nonrecourse debt;
- the owner fails to sell the property at a discount approved by the lender;
- the owner is going to vacate the property; and
- the mortgage holder is faced with starting or completing foreclosure.
A homeowner who signs and delivers a deed-in-lieu which is accepted by the lender essentially conveys their property to the lender in exchange for cancellation of the mortgage debt. Sometimes, it is financially advantageous for a lender to pay “key money” to the owner to arrange for the owner to vacate and convey title to the lender.
A property’s FMV as base year value for ownership
The base year value assessment for a property is reset to its fair market value (FMV) – the price a willing buyer would pay for it in the open market – every time a change of ownership occurs. Once the base year value assessment at FMV is determined, the assessed taxable value is set as derived from the base year value figure altered for exemptions and exclusions the owner qualifies to claim. The County Tax Collector then uses the taxable value to calculate the property tax levy.
When the ownership of a property qualifies for an exemption or exclusion from the payment of property taxes, the owner who remains qualified does not pay taxes on the exempt or excluded portion of the base year value of the property. It is the assessed taxable value at a lower amount which reflects the exemption or exclusions.
Since 1978, the County Assessor resets a property’s base year value when a change of ownership or new construction occurs on the property.
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A property’s assessed taxable value during any fiscal year may not be more than its current FMV. Thus, during a recessionary period of price declines, when a property’s assessed taxable value is higher than its market value, the taxable value is temporarily reduced to its FMV. However, the base year value remains in effect and subject to the annually factored base year value adjustment to reflect consumer inflation.
In following years, the property’s FMV is reviewed by the Assessor and the assessed taxable value is adjusted annually to match the rising FMV. When the FMV exceeds the factored base year value, the base year value as adjusted sets the assessed taxable value for property taxes going forward. [Rev & T C §51(e)]
Methods other than the comparable sales approach that are alternatively used to determine the FMV of a property include the cost approach which calculates the current construction cost to replace improvements, and the income approach which sets FMV using either:
- the gross rent multiplier (GRM) method; or
- the capitalization method.
The GRM method uses the market rent of the subject property determined by a survey of similar properties, which is then multiplied by a factor, the GRM, to arrive at a value for the subject property.
The capitalization method is a better approach to determine a property’s value as it is based on the property’s future income and operating expenses.
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Family revesting and exclusions from reassessment
Some transfers among family members do not constitute a change of ownership and do not trigger reassessment, or they are a change of ownership which triggers a partial reset of the assessed taxable value, including:
- Inter-spousal – when the transfer of property is between a husband and wife, no reassessment takes place, including transfers resulting from divorce or death. [Rev & T C §63]
- Domestic partners – transfers between registered domestic partners are likewise excluded from reassessment. [Rev & T C §62(p)]
- Parent-child exclusions – parents may transfer their family home and farm to children as a change of ownership with a dollar exclusion from the FMV base year value reassessment to set the assessed taxable value conditioned on the child occupying the home as their primary residence or operating the farm. Transfers from grandparents to grandchildren who occupy are also excluded from reassessment when both parents of the grandchild are deceased. [Prop 19 in 2021]
The parent-child exclusion from reassessment on transfer of each the family home and the family farm is limited to $1,000,000 in the property’s FMV which exceeds the property’s factored base year value prior to transfer. When the home’s FMV exceeds the sum of the parent’s factored base year value and the $1,000,000 exclusion, the assessed taxable value is set as the sum of the parent’s factored base year value plus the amount of FMV exceeding the combined factored base year value for the parents and the $1,000,000 exclusion.
Thus, the parent-child exclusion sets the assessed taxable value for ownership by the child who occupies the home as their primary residence as equal to a $1 million reduction from the new base year value reassessment for the property at FMV triggered by the change of ownership on conveyance to the child. Stated another way, any amount of market value in the family home exceeding the combined limit of the factored base year value prior to transfer and the $1,000,000 exclusion is added to the parent’s factored base year value – assessed taxable value – carried forward on the change in ownership. [Prop 19 in 2021]
The assessed taxable value, adjusted for inflation annually, applies to the property so long as the child qualifies by occupying the property as their primary residence.
Loss of exclusion trips use of factored base year value
When a new ownership constitutes a change of ownership, the Assessor determines the property’s FMV and sets a new base year value assessment for the property. The base year value assessment remains with the property, factored annually for inflation to set the taxable value.
However, when the new ownership has exclusions from its taxable value but the family in some future year no longer qualifies for the exclusion, the factored base year value becomes the assessed taxable value of the property.
Consider a parent who transfers their primary residence with a FMV of $1,500,000 to their adult child who will occupy it as their primary residence. The parent’s factored base year taxable value for the property is $300,000.
The amount of the factored base year value prior to transfer plus the exclusion of $1 million equals $1,300,000.
But the FMV of $1,500,000 is greater than the $1,300,000 of the combined prior base year value and the $1,000,000 parent-child exclusion. Thus, the excess in the home’s FMV beyond the $1,300,000 figure is $200,000. Thus, this excess FMV is added to the parent’s $300,000 factored base year value to reset the assessed taxable value for the child.
However, the new base year value assessment for the child is set at $1,500,000, not the new taxable value, on the change in ownership to the child. In future years when the child no longer qualifies as the occupant of the property as their primary residence, the assessed taxable value becomes the child’s base year value adjusted for the intervening years of inflation, called the factored base year value assessment.
Had the property’s FMV been less than $1,300,000, the parent’s assessed taxable value becomes the child’s assessed taxable value under their new ownership with the exclusion. Thus, they will not pay property taxes any greater than paid by their parents – again, so long as they continue to qualify for the exclusion by occupying the home as their primary residence. The child’s base year value will become the FMV of the home on its transfer to the child.
