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What To Know About Structuring A Buyout In A California Trust Or Estate

What happens when one beneficiary wants to buyout another beneficiary’s interest in an inherited property?

You might think this is a simple and straightforward process – one beneficiary compensates the other(s) for their share of the property and voila – takes the property. But here’s where you have to watch out. If everything isn’t done just right, property taxes could skyrocket unnecessarily.

Before we get into the details, let’s lay out the typical scenario for a successful buyout in a California trust or estate.

1.        A person passes away, leaving his or her assets to designated beneficiaries or heirs.

2.       The person (called the decedent) owned a property that one beneficiary would like to own/live in.

3.       The other beneficiaries prefer to have cash distributions.

In order for one beneficiary to take full ownership of a property that others are also legally entitled to, he or she must “buy out” the other beneficiaries. For a beneficiary who is not a child of the decedent, this is a relatively straightforward mathematical transaction.

But, if the beneficiary is a child of the decedent and intends to live in the property, that beneficiary has the possibility of avoiding hefty property tax increases. That’s because California law allows for a Reassessment Exclusion for Transfer between a Parent and Child – when that transfer meets certain conditions.

So how does the child who gets the home avoid unnecessary property tax increases?

A Typical “Buyout” vs. an “Equalizing distribution” for Property Tax Purposes:

When it comes to trust or estate properties bequeathed to multiple individuals, a straight Buyout is one beneficiary buying out the others’ shares. The beneficiary could use their own cash, their inherited cash, or a private loan in order to compensate the other beneficiaries for their shares. But – If you do this – watch out. The Board of Equalization (who oversees the County Assessor) says that the portion of the property obtained from the other beneficiaries (typically siblings) is subject to reassessment – because only part of the property is from the parent, and only that part will be exempt.

Here is where the “equalizing distribution” comes into play. While an equalizing distribution accomplishes the same purpose as a straight buyout, an equalizing distribution is wholly different from a buyout in the eyes of the Board of Equalization.

If the trust or estate has enough cash, the beneficiaries have two options. Option number one is the most straightforward: If the trust says you can have a non pro rata distribution (or doesn’t say it has to be pro rata) then one beneficiary can take cash and the other can take the property. For a Probate buyout, the Petition for Final Distribution must ask the Judge for a “non pro rata” distribution. If the trust does not have the required language (or absence thereof), the trust “loans” the beneficiary the funds to buyout the other beneficiaries.

On the other hand, If the trust or estate does not have enough cash, the trust must take out a loan in order to compensate the beneficiaries that are not getting the property. The beneficiary receiving the property can then take ownership to the property subject to the trust loan and obtain a new loan to pay off the trust loan once the house transfers title. Trust loans can be expensive, but are often worth it to maintain the property tax base.

Two More Important Considerations When Considering a Buyout:

As if that weren’t enough to think about with regards to a potential buyout, here are two more important issues to consider:

  1. Limitations on Property Tax Reassessment ExclusionThe wonderful thing about inheriting a property in California that you plan to reside in is that you won’t have to pay property taxes on the current market value of the home. However, if the current market value is over $1 million, you will have to pay property taxes on that amount. That’s because the Parent Child Exclusions is limited to $1 million.
  2. Trust/Estate AdministrationWhen you’re contemplating a buyout in a CA trust or estate, proper administration of the trust or probate becomes all the more important, as you need everything to be in order to successfully complete each step of the property transfer.

When done correctly, buyouts offer great savings and benefits to beneficiaries in California. To ensure you get those benefits, this is one process where you’ll definitely want to hire an experienced professional.

If you’re considering structuring a buyout within a California Trust or Probate Estate, call our California Trust and Estate Planning Law Firm at 925-322-1795 to set a consultation.

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