Commercial Real Estate Investor Strategies After Prop 19 in California

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Under the newly passed Proposition 19 in California, property taxes on commercial real estate will now be reassessed upon any transfer from parent to child.  This new consequence of death will likely lead to the sale of many inherited commercial real estate investment properties because the reassessment renders the property a less desirable investment.  However, can parents still transfer such property to their children without reassessment?  Possibly.

Assume, for example, the parents own an apartment building, and have two children, Colleen and Patrick. They desire to transfer their apartment building equally to Colleen and Patrick in such a way that the property is never reassessed – not when they make the transfer, not when they die, and not when Colleen and Patrick pass the property on to their children.  This transfer may be possible, even after Prop 19, if done as follows:

  1. Parents form a new Limited Liability Company called “LLC-1.” They move the apartment building into LLC-1 and give 50% of the membership interests to Colleen. Because Colleen received 50% ownership, no “transfer” occurred, and the property is not reassessed. Parents cannot include both Colleen and Patrick in LLC-1 at 50% each, because the total transfer would equal more than 50%, triggering a reassessment.
  2. Now, parents train Colleen on how to manage the apartment building over the next year or so, waiting because they want to see how it goes being partners with Colleen and they need to avoid any possible issue with the “Step-Transaction Doctrine” that might compress all their moves into one “step” under the law. (While this doctrine does not currently apply to intra-family actions, that law will likely change due to Prop 19).
  3. A year later, parents decide that managing the properties with Colleen was not such a good idea, so they dissolve LLC-1, with 50% of its assets (the property) going to parents and 50% going to Colleen. They need to do this to enable the next step.
  4. Then parents wait another year while holding the property as 50/50 tenants in common with Colleen.
  5. Now parents and Colleen form LLC-2 to hold the property, after which they give their 50% of the shares in LLC-2 to Patrick. Now Colleen and Patrick own the property and manage it together.
  6. If parents have more than two children, they will need to repeat the process until everyone gets their cut—and no transfer exceeds 50%.
  7. When Colleen and Patrick have kids, they will want to dissolve LLC-2 and temporarily take their halves under their own ownership.
  8. Then they can form LLC-3 and repeat the process for the next generation.

If you do this correctly, the property will never be reassessed. And you can even stay on as manager of the LLC while you are alive. Successor managers can manage the LLC similarly to the way a trustee manages a trust.

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