By: Tamara Pow
As a real estate attorney in Silicon Valley, I represent a lot of real estate investors that hold their properties in LLCs. One of the biggest and most expensive mistakes LLC members can make when transferring property to or from an LLC is triggering a reassessment of their real property, yet this complex area of taxation is often not well understood by real estate owners or even accountants or attorneys that do not specialize in this area. The general rule is that any transfer of real estate is an event causing both transfer taxes and the reassessment of the property for property taxes. The role of the tax advisor, whether a CPA or real estate or business entity attorney, is to either prepare the client for this eventuality in advance so they can decide whether or not to proceed, or to structure the transaction to fall into one of the exceptions.
A contribution of real property to an LLC on the formation of an LLC is a change of ownership, triggering reassessment for California property tax purposes, unless all of the following three circumstances apply :
- The transfer is between legal entities or between one or more individuals and an entity;
- The transfer is solely a change in the method of holding title; and
- The proportional interests in the property (directly or through the entity) remain the same before and after the transfer.
This means that one or more owners of real property can transfer the real property to an LLC and take membership interests in the LLC in the same percentages in which they previously owned the property directly and there will be no change in ownership, and therefore no reassessment for property tax purposes and no transfer taxes. Be very careful with percentages – they must be identical. I recently had to argue a case with the Santa Clara County Tax Assessor’s Office in which an attorney helped two co-owners of real estate transfer their property to an LLC. One owned one-third of the property, which was noted on the deed as 33 1/3%, and the other owned two thirds of the property, noted on the deed as 66 2/3%. However, when the attorney drafted the LLC operating agreement, he rounded the percentage interests to give the first owner 33% and the second owner 67%. The result was that the property was reassessed and the partners could not claim that the indirect ownership percentages were identical before and after the transfer to the LLC.
Even though the contribution to the LLC may not be a change of ownership, the property could still be reassessed later as a result of a member’s transfer of an interest in the LLC resulting in either a change in ownership or a change in control. A change of ownership results when more than 50% of the total interests in the LLC are transferred by the original co-owners. A change in control results whenever a person or entity obtains direct or indirect ownership of more than 50% of the total membership interests in the LLC. One of the many reasons experienced real estate attorneys encourage their clients to take title to property from the beginning in the name of the LLC (rather than taking title in their own names and then transferring to an LLC) is to avoid the change of ownership risk.
If title to the property is being transferred by deed, the County receives a “PCOR” or preliminary change of ownership report form whereby the transferee reports the new ownership and claims any exclusions from reassessment. If LLC membership interests are being transferred, the property remains titled in the LLC, so no deed or PCOR is filed. Instead, the members are required to file a change of ownership of real property form with the State Board of Equalization within 90 days of any change of more than 50% of the original co-owners (cumulatively – in one or more transaction) or any change in control. Failure to timely file the Form BOE-100 can result in a significant penalty. For more information on the change of ownership form go to the BOE website .
Once a property has been reassessed it is usually impossible to reverse unless a mistake was made, and it is difficult and expensive to argue for a reversal even for a mistake. Before transferring real property into an LLC or from an LLC out to its members, and before transferring membership interests in an LLC, be sure to consider the potential property tax implications.
I am one of the very few LLC attorneys that has an MBA, my real estate broker’s license and experience in public accounting. I therefore understand the importance tax planning plays in choosing an LLC as the proper form of entity for business and real estate investments.
The information appearing in this blog does not constitute legal advice or opinion. Such advice and opinions are provided by the firm only upon engagement with respect to specific factual situations. Specific questions relating to this article should be addressed directly to Strategy Law, LLP.