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BOE Walks Into the Valli Decision

Advisors as the effect of property tax on transfers of interests into legal entities may want to consider the recent State Board of Equalization (BOE) Letter No. 2018/014 on February 12, 2018.  We anticipated this letter a few years ago.  The 2014-year decision by the California Supreme Court in In re Marriage of Valli, 58 Cal.4th 1396 (Valli) changed how Assessors must decide which spouse/partner owns real property or a legal entity as to interests acquired during marriage (or a domestic partnership).

Background

For property tax purposes, Property Tax Rule 63 (Rev. & Tax. Code, § 63) excludes from reassessment any inter-spousal transfer of property.  This exclusion avoid reassessments for transfers of property between spouses (“direct transfers”) and transfers between spouses of interests in legal entities, i.e., partnerships, LLCs and corporations, that hold real estate (“indirect transfers”.)

Because the inter-spousal exclusion does not apply to transfers between individuals and legal entities, however, whether property acquired during marriage was separate or community property could trigger reassessment traps if the percentage ownerships were not the same.  (See Annotations 220.0274, 220.0278.)  This meant that for transfers between entities and spouses, there often had to be “double deeding” or legal entity corrections to clean up title so that the proportionate transfer applied.

In addition, as explained below, before this ruling, the failure observe the title of property acquired during marriage might result in missing out on doubling the $1 million per person parent-child exclusion by joint gifts (allowing up to $2 million) for non-personal residence property transfers to children.

Life Before Valli

Before Valli, BOE and Assessors advocated that legal title held by just one spouse, even if acquired during their marriage, would not be treated as community property owned “50/50” with the other spouse absent contrary “clear and convincing evidence.”  BOE Letter dated October 27, 2010 BOE Letter dated May 14, 1993 and (Property Tax Annot. 220.0044 and 220.0278)  This level of proof could prove difficult, and Assessors relied usually solely on title documents to determine ownership as to both real property and legal entities, absent the spouses providing a written agreement or other recorded document clearly showing that the property or legal entity remained community property between the spouses/domestic partners.  This position was supported by case law dating back 27-years, In re Marriage of Lucas (1980) 27 Cal.3d 808 (Lucas) and most recently in the decision of In re Marriage of Brooks & Robinson (2008) 169 Cal.App.4th 176 (Brooks).   For the 2008 decision involving a divorce, in fact, a Mrs. Robinson was found to be the sole owner of property acquired during marriage when she took sole title to the family home not withstanding that Mr. Brooks paid for all home expenses and the mortgage out of community property funds.

Entering the Valli Decision

In BOE Letter No 2018/014 the legal division staff advises Assessors that the older annotations and case decisions should no longer be followed.  During the 2014-year, California Supreme Court ruled that life insurance titled with just one spouse as owner should be treated as community property notwithstanding.  Because it had been acquired during marriage, the court specifically rejected that the documented title ownership would overcome the recognition of 50/50 community property ownership, which was presumed by law.  What was critical is that the court rejected prior law and court found that even if one spouse “consents” to having one spouse on title, the California transmutation statutes require that there must be a writing, signed by the adversely affected spouse, that “expressly state[s] that the character or ownership of the property at issue is being changed.”  Absent that, the policy remained community property.

In BOE Letter No 2008/014, the Board legal staff found that this insurance decision applies to all property of every kind, both real property and interests in legal entities.  Accordingly, Assessors must carefully check whether the interests whether in property or legal entities involves community property interest held by spouses 50/50 and not rely on title documents alone.

Expanded Assessor Requests

While for estate planning purposes, we have been warning clients for years that simply changing title in property and legal entities does not in California convert community property into separate property, the Valli decision affirms this warning.  Title on deeds and legal entity documents are not conclusive as to whether there is a 50/50 community property interest held by a spouse.  Accordingly, Assessors are now facing the same difficult issue.  Because they cannot rely on title documents or partnership, LLC or corporate ownership documents to determine between spouses whether property is separate or community or transfers to legal entities should be reassessed, Assessors now need to make intimate divorce court like inquiries to determine if ownership is in fact 50/50 as community property.  There are likely to be more situations where the Assessors will find that the proportionate transfer rule to avoid reassessment applies.

In addition, BOE Letter No 2018/14 advises Assessors to ask for intimate proof on transfers between individuals and legal entities.  Examples of documents that may be requested include legal entity formation proof, marriage certificates and domestic partnership registrations, proof whether spouses/partners were California domiciled and copies of any private written transmutation agreements between spouses.

Property Tax Planning

There is a plethora of property tax planning connected to BOE Letter No. 2018/14.

No More Double Deeding?

First, while the trend will be for more intimate inquiries, the fact that title to property is held in one spouse alone will no longer be as conclusive with the Assessor as to whether property is separate or community property.  If property is shown to be acquired during marriage, Assessors generally must accept the community property presumption absent evidence of a transmutation agreement.

Second while as a practice point, while the proportionate transfer rule avoids  reassessment between individuals and legal entities where the proportional ownership interests remain the same after the transfer, the issue remains whether one should undertake “double deeding”.  Property Tax Rule 62(a)(2).  Double deeding involves for contributions to a legal entity, an initial “extra” deed to clean up property title to match the ownership in the legal entity title.   Double deeding may still be a good idea, and while not necessarily required as to spouses, if the community property presumption applies, it may clean up title to conform with intent.  It may also be used for parent-child transfers that may qualify for exclusion, wherein only direct deeding to a child may qualify for an exclusion.  Once completed, the second deed must match ownership in the legal entity so that interests remain proportionate.

Other Concerns.

While the BOE letter focused principally on transfers between individuals and legal entities, the Valli decision has extensive property tax planning implications.  In California property tax planning is a required element to undertaking any tax planning.  The application to avoid reassessment or to apply reassessment exclusions requires careful review and analysis.

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