MCLE Article: Legal Entities and Real property: Limiting Reassessment

Legal practitioners have rightfully promoted the many advantages of holding real property in corporations, limited liability companies (LLCs), and other legal entities. By doing so a landowner can limit personal liability, exercise a degree of anonymity, and realize various tax efficiencies. However, when advising clients regarding the transfer of real property to a legal entity, due diligence requires careful consideration of any property tax consequences. 

With the passage of Proposition 13 in 1978, voters drastically altered California’s real property tax regime. Property taxes are now assessed on a property’s 1975 value, as adjusted for inflation by no more than 2% per year. A re-appraisal of real property occurs only where one of the following events takes place: (1) new construction on the property or (2) a change in ownership. 

In the context of holding real property in a legal entity, the more common event leading to possible reassessment is a change in ownership. California law sets clear rules on when a transfer constitutes a change in ownership. This area of the law is based on several decades of practice and case law and is therefore well developed. Moreover, because the Proposition 13 regime has depressed the assessed value of property statewide, local tax authorities will not hesitate to characterize a real property transfer as a change in ownership in the event of an error. It is therefore very important to understand and follow these rules. The following are the most common change in ownership exclusions applicable to legal entities. Excluded are the less common situations of mergers, acquisitions, and transactions between affiliated entities, as well as specific rules applicable to partnerships and cooperative housing corporations. 

A. CHANGE IN OWNERSHIP 

The California Revenue and Taxation Code defines a “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.”2 This expansive definition, clarified by other sections of the code and regulations, covers most common transfers, whether voluntary, involuntary, or by operation of law. 

B. TRANSFERS OF INTEREST IN REAL PROPERTY 

The general rule is that “the transfer of any interest in real property between a corporation, partnership, or other legal entity and a shareholder, partner, or any other person” is a change in ownership.4 This general rule is applicable in arms-length transactions. If Person A and Corporation B have no relationship and Person A sells an interest in land to Corporation B, this is a change in ownership and the property will be reassessed. Likewise, if Corporation B later sells to Limited Liability Company C, there is another change in ownership. 

The exception to this rule is what is known as the proportional interest transfer change in ownership exclusion. There is no change in ownership in a transfer between individuals or entities “that results solely in a change in the method of holding title to the real property and in which proportional ownership interests of the transferors and transferees . . . in each and every piece of real property transferred, remain the same after the transfer.”5 For example, if Person A owns land and is the sole shareholder of Corporation B, the transfer from A to B of the land will not be a change in ownership because the proportional ownership interests are identical and because the transfer simply changes the method by which Person A holds title: from himself as an individual to his corporation. 

Now assume that Person A owns all of Parcel 1 and Person B owns all of Parcel 2. Both parcels are of equal value. Persons A and B each own 50% of the membership interest in Limited Liability Company X. Each person’s capital contribution to the LLC is their respective parcel. In this situation there is a change in ownership and each parcel is reassessed. This does not fall under the exclusion because it is determined on a parcel-to-parcel basis: before the transaction, Parcel 1 was owned by Person A; after the transaction Parcel 1’s beneficial owners are now Persons A and B (the same analysis applies to Parcel 2). 

C. TRANSFERS OF INTEREST IN LEGAL ENTITIES 

The general rule applicable to the transfer of interests in legal entities that own real property is that “the purchase or transfer of ownership interests in legal entities, such as corporate stock or partnership or limited liability company interests, shall not be deemed to constitute a transfer of the real property of the legal entity.”6 Under this general rule, stock in a corporation can be bought and sold without characterizing that transaction as a change in ownership of the real property held by the corporation. There are two major exceptions to this rule. The first is for transfers that result in a change in control of the legal entity. The second is when “original co-owners” have cumulatively transferred more than 50% of their interest in the legal entity. 

C1. CHANGE IN CONTROL 

Control of a legal entity exists when one person (or entity) directly or indirectly owns more than 50% of the legal entity. For corporations, ownership means the voting stock. For limited liability companies and partnerships, ownership means both capital and profit interests. When there is a change in control, there is a change in ownership and the real property held by the entity is reassessed. 

An example of direct change in control would be as follows: Person A owns 55% of the voting stock of Corporation C, which owns real property. Person A sells all of his stock to Person B. There is a change in ownership in the underlying real property because of the change in control. 

An example of indirect change in control would be as follows: Assume the same facts as the previous example, except that Corporation C does not directly own real property. Instead, Corporation C’s has a 60% capital and profit interest in a limited partnership that owns real property. When Person A sells all of his voting stock to Person B, Person B now indirectly has control of the limited partnership. This change in control means that there is a change in ownership of the underlying real property, and reassessment of the real property is proper. 

C2. ORIGINAL CO-OWNER INTEREST TRANSFERS 

An original co-owner is a person who gains an ownership interest in a legal entity following a proportional interest transfer. Regardless of whether there is a change in control, once the original co-owners cumulatively transfer more than 50% of the ownership interest in the legal entity, there is a change in control.

For example, Persons A, B, and C own Parcel 1 as tenants in common. These persons transfer their ownership interest to Limited Liability Company X, of which each person owns a 1/3 interest. There is no change in ownership because this is a proportional interest transfer. Persons A, B, and C are now deemed “original co-owners.” Person A sells his LLC interest to Person D. There is no change in ownership. Sometime later Person B sells his LLC interest to Person E. At this point there is a change in ownership because the original co-owners have cumulatively transferred more than 50% of the total interests in the LLC. Note that there is no change in control because no person has directly or indirectly obtained more than 50% ownership interest in the LLC. 

However, there are several transfers that do not count as an original co-owner interest transfer: (1) transfers between spouses or between registered domestic partners, (2) transfers to or from a trust established for the trustor’s benefit (or the benefit of the trustor’s spouse or registered domestic partner), (3) a proportional interest transfer, and (4) transfers which have already been counted. 

For example, Person A owns 60% and Person B owns 40% of Parcel 1 as tenants in common and they each transfer their interests to Limited Liability Company Y and maintain their respective ownership interests. Person A and B are now original co-owners. Person A transfers all of his interest to his spouse. 

In another example, Persons A, B, C, and D become original co-owners after transferring their tenant-in- common interests in Parcel 1 to Corporation X, of which each person owns 25% of the voting stock. Person A sells all his stock to Persons B, C, and D, all of whom now own 1/3 of the shares. If Person B where to then transfer his shares to a third party, there would be no change in ownership. Because original co-owner interests are not to be counted twice, only 50% of the original co-owner interests have been transferred: 25% from Person A and 25% from Person B. Note that the transfers between original co-owners are counted as transfers of original co-owner interests. 

When considering transfers of interests in legal entities, it is also important to remember that common exclusions to the general change in ownership rule are not always applicable. Transfers of real property between parents and children, as well as grandparents and grandchildren, are not considered changes in ownership under some circumstances. However, both the parent-child and parent-grandchild exclusions specifically do not apply to transfers of interests in legal entities.

C3. REPORTING CHANGE IN OWNERSHIP OR CONTROL 

Changes in Ownership and/or Control are monitored by the State Board of Equalization. Whenever there is a change in control pursuant to section 64(c) or a change in ownership pursuant to section 64(d), and the legal entity owned or leased an interest in California real property as of that date, the person or legal entity acquiring ownership control or the legal entity that has undergone a change in ownership must file the BOE-100-B, Statement of Change in Control and Ownership of Legal Entities (statement) with the Board of Equalization (BOE) at its office in Sacramento within 90 days of the change in control or ownership . In addition, any legal entity is required to file a statement with the BOE within 90 days of the date of the BOE’s request regardless of whether a change in control or ownership of the legal entity has occurred. 

D. CONCLUSION 

While almost any transaction involving real property will be considered a change in ownership, transfers to and between legal entities can be structured to fall within one of the many exclusions. Although real property transfers to and between legal entities are changes in ownership, the proportional interest transfer exclusion can be relied upon to change title and transfer property in and out of LLCs or corporations. Likewise, although one must be mindful that a change in control or the transfer of a majority of the original co-owner interest will cause a change in ownership, there are many ways to structure transactions to rely on the general rule that transfers of interests in legal entities are not changes in ownership. 

ENDNOTES 

  • 1  Cal. Const. art. XIII A, § 2.
  • 2  Cal. Rev. & tax Code § 60.
  • 3  See Cal. Rev. & tax Code § 61; Cal. Code Regs. tit 18, §§ 460–462.500.
  • 4  Cal. Rev. & tax Code § 61(j).
  • 5  Cal. Rev. & tax. Code § 62(a)(2).
  • 6  Cal. Rev. & tax. Code § 64(a).
  • 7  Cal. Rev. & tax. Code § 64(c)(1).
  • 8  Cal. Rev. & tax. Code § 64(d).
  • 9  Cal. Code Regs. tit. 18, §§ 462.180(d)(2).
  • 10  Cal. Rev. & tax. Code § 63.1.
  • 11  Cal. Rev. & tax. Code § 63.1(c)(8).
  • 12  Cal. Rev. & tax. Code §§ 480.1 & 480.2.
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