As California struggles through its economic downturn, local tax authorities are looking for ways to increase tax revenues. And property owners may not be aware of the tough penalties they could face if they fail to quickly report changes in ownership.
Most California property owners know that changes in ownership result in property tax reassessment under Proposition 13, and such reassessments are typically triggered when a transfer deed is recorded.
What may surprise some taxpayers is that changing the ownership of a legal entity that holds the real property may also trigger a reassessment. This occurs even if the property-owning entity, such as a corporation, remains the recorded owner of the underlying real property.
Legal entity transfers have long been a concern for California tax authorities. Real property transfers caused by a change in an entity’s ownership are not documented by a recorded deed, which is the normal manner in which tax assessors learn of property ownership changes. In this circumstance, tax authorities must look to state franchise tax returns and business property filings to discover ownership changes affecting real property.
In recent years, state and local governments have become more aggressive in their efforts to identify ownership changes in entities holding real property.
Previously, it was up to the tax authorities to identify those changes and provide taxpayers with the appropriate reporting forms. Last year, tax authorities upped the ante considerably – giving property owners the job of reporting legal entity transfers within strict deadlines and removing the tardy reporting “grace” period.
Delays in reporting can trigger consequences
Now owners who fail to report transfers quickly are subject to significant penalties on all of their California properties, even if only one property changed ownership as a result of a legal entity transfer.
Additionally, the revised law requires reporting of ownership changes even in cases where the transfer falls under a change of ownership exception. Those exceptions include transfers of less than a controlling interest in a legal entity, and transfers in which the type of entity changes, say from a corporation to a limited partnership, but the owners and their ownership percentages remain the same.
In effect, the revised law penalizes the failure to file the requisite reporting form, regardless of whether there has been a change in ownership of the underlying real property.
More tax liability?
If the above did not already cause enough headaches, local tax authorities have added to property owners’ burdens by attempting to expand another California tax – the documentary transfer tax (DTT) – to include legal entity transfers.
Traditionally, the DTT has only been collected upon the recording of a deed or similar instrument transferring a property’s ownership. In fact, the DTT is usually understood to be an excise tax on the right to transfer property and use county recorder services.
This view has recently changed as Los Angeles County and other local jurisdictions seek to bring legal entity transfers where no document is recorded within the purview of the transfer tax law. They have been aided in their discovery of such transfers by statutory changes which give county recorders access to the records of county assessors’ offices.
As a result, county recorders’ offices now have access to legal entity transfer information which was once only available to county assessors. Armed with this new information, counties and cities are seeking to charge transfer taxes on entity transfers where no deed has been recorded.
Fortunately, property owners can repel attempts by county recorders and city clerks to collect transfer tax. Most counties and cities have ordinances adopting California’s statewide statute regulating the issue.
That statute, with one limited exception relating to dissolution of partnerships through a legal entity transfer, only permits collection of DTT when a deed or other instrument is recorded. Property owners confronted with a request for payment of the tax for a legal entity transfer need only point to the local ordinance in order to parry the unlawful attack.
So long as California remains in its economic downturn, the local tax authorities will continue to be vigilant in looking for ways to increase tax revenues. And real property owners would do well to report legal entity transfers promptly to avoid draconian penalties.
Fortunately, efforts are under way to eliminate the harsh effects brought about by the recent changes in legal entity transfer reporting. As for the documentary transfer tax, property owners should only pay that tax on transfers made by a recorded document. And, as with every transfer of real property in California, property owners should consider whether their transfer falls under one of the exceptions to a change in ownership in order to avoid reassessment.
Cris K. O’Neall specializes in ad valorem property tax matters as a partner in the Los Angeles law firm of Cahill Davis & O’Neall LLP, the California member of American Property Tax Counsel, the national affiliation of property tax attorneys. He can be contacted at [email protected]ahilldavis.com.