This article presents the exclusion from reassessment on a child’s acquisition, by sale or gift, of property conveyed to them by their parents or grandparents. 

Exclusion for gifts and sales 

An older couple owns residential income properties that are unencumbered by mortgage debt. They would like to rid themselves of the management and are considering selling the rentals. The sales proceeds would be reinvested in interest-bearing notes and bonds. The situation is discussed with their children, who live nearby and have had experience in all aspects of managing the properties. 

The children express an interest in acquiring the properties as investment income for themselves, taking on the management their parents no longer want. 

The couple, having already reviewed their situation with a real estate agent, now discusses the possibility of selling the properties to their children with the assistance of the agent. The couple desires a fully documented and arm’s length arrangement with their children, but at a price below the current fair market value of the property and without a down payment in cash. 

The couple does not want their children to use their own cash to buy the properties and will carry an installment note at the minimum applicable federal rate (AFR). The broker expands the discussions to include the possible sale of the couple’s principal residence to one of the children who lives locally and could use a larger home for his family. 

The couple is intrigued by the broker’s comments on the ability of their children to become the owners of the properties without reassessment on the property tax rolls to current fair market value. 

One of the properties has a market value of $1,100,000. Conveying the property to an investor would be a change of ownership triggering reassessment of the property to its current full cash value — $1,100,000. The property’s present assessed value is $500,000, which comprises a $325,000 basis and a maximum annual inflation adjustment during their ownership of 2% per annum, compounded. While the taxes now paid by the parents are $5,000 annually, a buyer on acquiring the property would pay $11,000 annually in taxes since the property would be reassessed at current market prices (full cash value). 

The children, on the other hand, qualify to acquire the property without reassessment. Each parent has a separate exclusion from reassessment when transferring properties to their children. Each exclusion covers the properties’ current assessed values up to $1,000,000. Thus, the couple holds a combined exclusion of $2,000,000 in assessed value, which can be applied to a sale or gift of properties to their children, without regard to the current fair market values of the properties. 

Thus, the children, on buying the apartment building, continue to pay the same property taxes their parents paid; there is no reassessment and no increase in taxes. The children save $6,000 in property taxes during the first year alone by buying their parents’ properties rather than acquiring a comparable property of the same value from another seller. Each year thereafter, the amount of tax savings will increase since the 2% annual inflation adjustment is based on the assessed value ($500,000), not on the current fair market value of $1,100,000. 

Further, the current property taxes are 5% of the gross rental income. The purchase of the couple’s property by a non-family member would cause the taxes to rise, expending over 10% of the gross rental income on the payment of property taxes. Thus, the purchase of the properties will increase the children’s net operating income by $6,000 the first year, providing an extra cushion against any downturn in the local economy that might increase the rate of vacancies and turnover of tenants. 

As for the couple’s principal residence, a separate exclusion without any assessed value limitation (and no fair market value limitation) allows a child to acquire his parents’ residence without triggering reassessment. The child is permitted to take over the parents’ assessment since the property is the principal residence of the parents. Thus, the annual cost of owning the residence will not increase on conveyance to the child, as it would if any other person bought the residence. 

The couple quickly concludes it is financially advantageous to keep the properties within the family, especially since they have good reason to believe their children have the temperament and ability to operate the rentals successfully. 

The broker’s duties will include: 

  • assisting and advising in preparation of a purchase agreement; 
  • setting an agreeable price; 
  • setting the terms of payment by obtaining a purchase-assist mortgage or using a carryback note with an acceptable rate of interest; 
  • dictating escrow instructions; and 
  • assisting with the change of ownership report the children must file with the assessor on taking title. 

It is the report to the assessor that will set forth their claim of exclusion for reassessment, since each parent has a $1,000,000 assessed value exclusion available for the children to claim. 

Assessed value 

Local property taxes are imposed and collected according to a real estate’s full cash value on the date of acquisition (the change of ownership), which is adjusted annually for inflation up to 2%. The higher the assessed value, the greater the tax. 

Local taxes are limited to one percent of the property’s assessed value for the fiscal year (July 1 to June 30). [Calif. Constitution, Article 13A §1(a)] 

Property taxes for the upcoming fiscal year are set based on a property’s assessed value, which is its full cash value set on either: 

  • March 1, 1975, plus an annual 2% maximum adjustment for inflation [Calif. Revenue and Taxation Code §110.1; Calif. Const., Art. 13A §2(a)]; or 
  • the date the property is sold, is improved or undergoes any other change of ownership after March 1, 1975, plus the annual 2% maximum inflationary adjustments thereafter. [Calif. Const., Art. 13A §2(a)] 

Accordingly, property today is only reassessed when its ownership is changed or it is improved by construction or sustains a casualty loss that goes unreplaced. Also, temporary annual reductions occur if the property’s fair market value drops below its current assessed value. 

Since 1975, when the assessed full cash value of all taxable (non-exempt) properties was set, real estate market values have increased significantly beyond the price adjusted for the annual 2% inflation. 

An owner of real estate can benefit by retaining his ownership of a property since the property’s operating costs (and thus, property taxes) are less over time than they would be under new ownership. 

The 2% inflation ceiling on property taxes during ownership is a feature that induces owners to retain their properties, rather than sell and acquire new ones. 

Consequently, two neighbors owning adjacent properties with identical market values often pay vastly different sums on their property taxes, depending on when they acquired their properties. 

Before discussing the parent-child exclusions from reassessment on a change of ownership, it is necessary to first review what activities constitute a change of ownership and trigger reassessment on their occurrence. 

Change of ownership 

To trigger reassessment, a substantial change of ownership must occur. 

A change of ownership occurs when the owner transfers a present interest in the real estate, which: 

  • includes the beneficial use of the real estate; and 
  • has a value substantially equal to a fee interest. [Rev & T C §60] 

Every person acquiring an ownership interest in real estate must file a change of ownership report with the county assessor. On the change of ownership report, the buyer must indicate whether an exemption or exclusion applies. 

Unless the transfer is exempt or excluded from reassessment, the real estate interest conveyed must be reassessed at its current full cash value, typically represented by the price paid by the new owner. 

An exemption from assessment indicates the property is not considered taxable, such as real estate owned by: 

  • local, state or federal government; 
  • churches and religious organizations; 
  • universities and colleges; and 
  • charities and nonprofit hospitals. [Rev & T C §§201, 214] 

An exclusion indicates the property under the new ownership is taxable, but the transfer to the new owner does not trigger reassessment. Thus, the prior owner’s full cash value assessment, plus the annual adjustments for inflation, remains the assessed value for the new owner. [Rev & T C §§69.5, 201.4, 202, 203, 205.5] 

Frequently, the terms “exemption” and “exclusion” are carelessly interchanged. However, for transfers of privately-owned real estate to avoid reassessment, the new owner must depend on an exclusion by filing a claim with the county assessor at the time of the conveyance or within the period of limitations. 

Excluded transactions 

While most transfers of title trigger reassessment, some do not. For example, a mere change in the vesting used by an owner or owners to hold title to a property is not a change in ownership. However, the proportional interests held by the co-owners before they changed their vesting must remain the same after the transfer. 

Changes in vestings between joint tenants, tenants-in-common, community property or a co-owner’s partnership or corporation are excluded from reassessment as long as the share of ownership held by each co-owner remains the same in the new vesting. 

Also, transfer of a partner’s interest in a partnership, such as an assignment of a partner’s interest, that does not alter the control of the partnership, will not trigger reassessment of the real estate owned by the partnership. [Rev & T C §64(a)] 

A change in control by partners of a partnership that triggers reassessment occurs when more than 50% of the ownership interests held by the partners in the partnership are sold. Such a high percentage is one of the benefits of having several persons hold title in a limited partnership or LLC rather than as tenants in common. [Rev & T C §§64(c), 25105] 

Conversely, on the transfer of a fractional interest in the vested ownership of the real estate, such as the transfer of a tenant-in-common interest, that fractional ownership interest transferred is reassessed. [Rev & T C §65.1(a)] 

However, when a vested owner sells less than a 5% ownership interest valued under $10,000, it is not reassessed. [Rev & T C §65.1(a)] 

It is not possible, however, to exploit two exclusions in the same related series of transfers. The end result would be a reassessment without any exclusion. The multiple steps are collapsed and viewed as one step by the county assessor, and the property interest conveyed is then reassessed. [Crow Winthrop Operating Partnership v. County of Orange (1992) 10 CA4th 1848] 

Intrafamily transfers 

Transfers between spouses, called interspousal transfers, are also excluded from reassessment. Thus, no assessment will take place after the transfer between spouses. [Rev & T C §63] 

Transfers between husband and wife are not considered changes in ownership that trigger reassessment if the transfer: 

  • adds a spouse to title; 

reports the death of a spouse; or 

  • settles a divorce. [Rev & T C §63] 

Also, the transfer of a principal residence and up to $1,000,000 in assessed value of other real estate from a parent to his child, or from a child to his parent, is not considered a change in ownership that triggers reassessment. [Rev & T C §§63.1(a)(1), 63.1(a)(2)] 

The parent/child exclusion works in two ways — applying to transfers from parent to child or from child to parent. [Rev & T C §63.1(c)(1)] 

Generation skipping on death of a child 

Occasionally, grandparents lose a son or daughter by death, leaving only their grandchildren as direct descendants. For grandparents who wish to transfer their principal residence or other properties to their grandchildren, whether by sale or by gift, the principal residence exclusion and the $1,000,000 assessed value of other property can be used to avoid reassessment on the transfers. Thus, it is possible to skip a generation and pass on the same assessed value of the property at the time of transfer. 

However, a grandchild who has already been deeded the principal residence of his parent’s (now deceased) and has avoided reassessment on the conveyance by claiming the parent’s principal residence exclusion, cannot also receive a principal residence of the grandparent and claim another principal residence exclusion from reassessment. This bar against a grandchild receiving more than one property under a principal residence exclusion applies only to a transfer between grandparent and grandchild. 

On the other hand, the $1,000,000 reassessment exclusion held by grandparents can be used to exclude the transfer of the grandparents’ principal residence to a grandchild by treating it as other property. 

The $1,000,000 exclusion from reassessment each grandparent holds for conveyances to grandchildren is first reduced by any prior allocation of the $1,000,000 to transfers of property to their children. The exclusion amount is then reduced by any prior allocation on conveyances to grandchildren (after the death of the parent/grandparents’ child). The remaining amount of the exclusion is then further reduced by any amount of the deceased parent’s (grandparents’ child’s) $1,000,000 exclusion claimed by the grandchild to avoid reassessment of properties sold or given to the grandchild by the deceased parent. Thus, the grandchild does not receive more from the grandparents than the remainder of the $1,000,000 exclusion unused and held by their deceased parent. 

Also, a grandparent cannot sell or give his principal residence to his grandchild while, on the same transfer, making a claim to carry the assessed value of his principal residence forward to a replacement principal residence he acquires that is of equal or lesser value, in an attempt to simultaneously use the 55-or-older principal residence exclusion with the grandparent/grandchild exclusion. [Rev & T C §61.1(d)(1)(B)] 

Who qualifies? 

The parent-child exclusion only applies to transfers between parents and children. [Rev & T C §63.1(a)(1)] 

The definition of a “child” includes a parent’s: 

  • natural child [Rev & T C §63.1(c)(3)(A)]; 
  • stepchild or the stepchild’s spouse [Rev & T C §63.1(c)(3)(B)]; 
  • son-in-law or daughter-in-law [Rev & T C §63.1(c)(3)(C)]; and 
  • adopted child. [Rev & T C §63.1(c)(3)(D)] 

A child does not include: 

  • a natural child who has become the adopted child of another parent [Rev & T C §63.1(c)(3)(A)]; or 
  • a child who was adopted after turning eighteen years of age. [Rev & T C §63.1(c)(3)(D)] 

Each parent and child has two reassessment exclusions

  • the transfer of a principal residence; and 
  • the transfer of up to $1,000,000 assessed value of other property. [Rev & T C §§63.1(a)(1), 63.1(a)(2)] 

Principal residence 

To exclude the transfer of a principal residence from reassessment, the parent or child conveying their principal residence must now hold either: 

  • a homeowner’s exemption; or 
  • a disabled veteran’s residence exemption. [Rev & T C §63.1(b)(1)] 

Both are granted by the county assessor. 

The child or parent acquiring the property do not need to occupy the property as their principal residence to file a claim with the assessor for the reassessment exclusion. After the transfer, the child or parent receiving the property can use it for any purpose, such as a rental. 

No assessed value limit exists on the principal residence exclusion. The residence can be worth any dollar amount, be assessed at any dollar amount and still be transferred from parent to child, or child to parent, without reassessment. 

A principal residence is limited to the portion of land surrounding improvements that are used for dwelling purposes. This separates the portion of land used for other purposes from the portion of the land containing the residence, called apportionment. [Rev & T C §63.1(b)(1)] 

Thus, a residence on a large parcel is subject to apportionment on a transfer. A ranch, grove or subdivisible acreage transferred with a residence are examples of property that also require apportionment. 

A parent or child may transfer any number of their principal residences over the years under the principal residence exclusion. However, the dwelling must qualify as their “principal residence” at the time of transfer by having a homeowner’s or disabled veteran’s exemption. 

Here too, parents who transfer their principal residence to a child using the principal residence exclusion or the $1,000,000 other property exclusion to avoid reassessment on the conveyance to the child, cannot also use the 55-or-older assessment exclusion to carry their old assessment forward. Only one type of tax relief is permitted on the transfer of the parent’s principal residence. 

$1,000,000 assessment exclusion 

Parents and children can transfer all other real estate to each other without concern for the transfer of their principal residence, and up to $1,000,000 of current assessed value without triggering a reassessment. [Rev & T C §63.1(a)(2)] 

Each child and each parent has a separate $1,000,000 assessed value exclusion. When the real estate transferred by the parent or child has an assessed value under $1,000,000, it is transferred without reassessment. [Rev & T C §63.1(b)(2)] 

Likewise, if there are a number of properties, all will be excluded from reassessment if their total assessed value is under $1,000,000. [Rev & T C §63.1(b)(2)] 

Parents can combine their separate $1,000,000 exclusions to jointly convey property for a total combined exclusion of $2,000,000. Also, children can combine their individual exclusions when conveying jointly-owned properties to their parents. [Rev & T C §63.1(b)(2)] 

However, parents cannot combine their exclusion with a child’s in order to deed to another child without reassessment. To qualify for the $1,000,000 other property exclusion, the transfer must be from parent to child, or child to parent — not child to child, for which there is no exclusion available. Parent to parent transfers must qualify under the interspousal exclusion to avoid reassessment. 

Now consider a parent who uses his entire $1,000,000 exclusion to transfer property to one of his children. He cannot later transfer property other than his principal residence to another child without reassessment. For each child to equally benefit from the intra-family $1,000,000 reassessment exclusion, the parent may allocate a pro rata amount to each child as transfers occur, retaining the unused portion of the $1,000,000 exclusion for future transfers to other children. 

Allocation of exclusion to land or improvement 

The assessed value of the real estate owned by a parent and transferred to a child might exceed the amount of the $1,000,000 exclusion the parent has remaining or has allocated to a child for a transfer. 

When a child receives real estate that has a value exceeding the amount of exclusion available to him, he must allocate his exclusion to: 

  • the land only; 
  • the improvements only; or 
  • both land and improvements. 

When using the amount of the $1,000,000 exclusion available, an allocation should first be made to the portion of the real estate that has appreciated the most in market value, be it the land or the improvements. This is to avoid reassessment of the portion of the real estate that has inflated most in value above the assessed value. 

If the percentage increase in the value of the land is greater than the percentage increase in the value of improvements, the allocation should first apply to the land since any reassessment of the land will result in higher taxes than a reassessment of improvements would. 

If any amount of the exclusion remains, it should then be applied to the improvements. 

Conversely, when the percentage increase in the value of the improvements exceeds the percentage increase in the value of the land, the exclusion should first be allocated to the improvements. 

A reassessment is minimized by applying the exclusion first to the portion of the real estate that has increased at a higher rate. 

For example, a parent transfers a ranch to his child. The property has an assessed value of $1,500,000 — $1,000,000 to land (two-thirds) and $500,000 to improvements (one-third). 

The ranch’s current market value is $8,000,000 — $6,000,000 to land and $2,000,000 to improvements. 

The value of the land has appreciated $5,000,000 (500%) while the improvements have appreciated $1,500,000 (300%). 

The county assessor allocates the exclusion based on the assessed value ratio of land to improvements — $667,000 to the land and $333,000 to the improvements, totalling a $1,000,000 amount that will be excluded from reassessment. The balance of the property’s assessed value is $500,000 ($1,500,000 minus $1,000,000) and equals one-third of the property, which will be reassessed to reflect the current fair market value since it is not sheltered by the parent-child exclusion. 

Thus, one third of the property’s current market value of $8,000,000 is added to the $1,000,000 assessed value retained under the exclusion. Accordingly, the ranch’s reassessed value will be $3,670,000 — $1,000,000 plus $2,670,000 (one third of $8,000,000). However, the child in this example can further minimize his property tax liability by selectively allocating the exclusion only to the land. 

The child should allocate all of the $1,000,000 exclusion to the land since the value of the land has increased at a higher rate than the value of the improvements. The land then will not be reassessed since, at an assessed value of $1,000,000, it is fully sheltered by the amount of exclusion. However, the value of the improvements will be reassessed at current market value, to its full cash value

Here, the ranch’s new assessed value on reassessment of just the improvements will only be $3,000,000, represented by $1,000,000 (the excluded amount of the land’s value) plus $2,000,000 (the reassessed value of the improvements). The child minimizes the amount of future property taxes by selectively allocating the total exclusion to the land. The child saves an additional $670,000 through selective allocation, instead of using the assessor’s allocation ratio. 

Filing a claim 

To qualify for the principal residence exclusion or the $1,000,000 exclusion, each parent or child receiving property must file a claim for the exclusion with the county assessor. The claim should be filed with the assessor when the deed is recorded. It is noted on the change of ownership report form supplied by the assessor. The assessor, in turn, tracks the parents’ and children’s exclusion amounts through the California Franchise Tax Board (FTB). The FTB acts as a clearing house to monitor the total exclusion amounts claimed by each property owner. 

If, on the transfer of property, most of the $1,000,000 exclusion has been used already, the real estate will be reassessed and only the unused portion of the exclusion remaining will be granted. The balance of the real estate’s assessed value that is not excluded from reassessment will be reassessed for its pro rata share of the property’s full market value. 

Final considerations 

The parent-child $1,000,000 reassessment exclusion on a transfer does not cover real estate owned by the parent or the child that is vested in an LLC, partnership or corporation. [Rev & T C §61(j)] 

In a parent to child transfer, where title is held in a family partnership or corporation, the property should first be deeded back to the parent before he deeds it to the child under the exclusion. The two steps must be completed in separate, unrelated transfers, preferably in different fiscal years, to avoid the collapse of a two-step transaction into one step, which would lead to reassessment. [Rev & T C §63.1; Shuwa Investments Corporation v. County of Los Angeles (1991) 1 CA4th 1635] 

The child can, in turn, then transfer the property into his own partnership or corporation without reassessment. Again, the second transfer must be totally unrelated to the first transfer. 

Parent-child transfers to and from an inter vivos trust are excluded from reassessment. [Rev & T C §63.1(c)(9)] 

Also, no restrictions prevent a parent conveying property from continuing to occupy the transferred property. Also, the transfers do not necessarily need to take place as part of estate planning — although most probably do. 

The transfer to a child can occur at any time. 

The parent-child exclusion is an encouragement for families to retain ownership of their real estate rather than sell and obtain replacement property. 

For brokers, this means fewer sales of investment-quality real estate due to the owner’s ability to keep the real estate in the family and enjoy lower property taxes.