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Choosing a Business Entity for Your Rental Property, Part 2: California Property Taxes

By Bill Falor, Attorney
Noland, Hamerly, Etienne & Hoss
As published in the Salinas Valley Business Journal, November 2023

In September I wrote about choosing the right business entity for your rental property and, for several reasons, I landed on LLCs as perhaps being the best bet (depending, of course, on your set of facts). In that article I stated that, in determining the right structure for your circumstances, issues such as property taxes, estate planning, and administrative expenses and processes should be further explored with qualified counsel.  

In this article, we’ll cover the basics of one of those “other” issues: property taxes, specifically in California. 

Let’s say that when you and your friends contribute your interests in the rental property to the LLC, each of you receives a proportional membership interest in the LLC mirroring your ownership interest in the rental property.  What does this mean immediately for California property tax purposes?  Likely nothing, at least not when the property is initially contributed: absent certain specific circumstances, and so long as you and your friends receive proportional membership interests in the LLC, the property will not be reassessed when it is initially contributed to the LLC and, as a result, your property taxes will stay the same immediately before and immediately following the contribution.

However, let’s say that after the property is contributed to the LLC, one or more of the members transfers their LLC membership interest to someone else – for example, they gift it to a child for estate planning purposes or they sell it to a third party.  When that happens, things get complicated – in particular, if either (a) someone acquires more than 50% of the LLC membership interests, or (b) more than 50% of you and your friends’ membership interests are cumulatively transferred (i.e., regardless of whether any one person or entity obtains more than 50%), the rental property will be reassessed to fair market value for property tax purposes and your property taxes will increase if the rental property has appreciated in value since it was initially contributed.

There are strict reporting requirements for LLCs that undergo one of the above events, so if you transfer your rental property to an LLC, you should use caution when making later transfers of membership interests (as you otherwise may inadvertently trigger a property tax reassessment).  Further, you should always have clear and accurate records of ownership transfers from the day the LLC is established so you can track the cumulative effect of prior transfers.  

As in the first article I wrote on this topic, the above analysis is not exhaustive with regard to the above hypothetical scenario, and every situation is unique and should be approached in coordination with qualified counsel. Should you have any questions or need advice on your specific situation, the attorneys at Noland, Hamerly, Etienne & Hoss can help.

This article is intended to address topics of general interest and should not be construed as legal advice.  
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