BILL ANALYSIS
SENATE JUDICIARY COMMITTEE
Senator Joseph L. Dunn, Chair
2005-2006 Regular Session
SB 333 S
Senator Campbell B
As Amended April 19, 2005
Hearing Date: May 10, 2005
Revenue and Taxation Code 3
MJM/GWW:rm 3
3
SUBJECT
Exemption from Property Tax Reassessment: Transfer of Life
Estate Interest
DESCRIPTION
This bill would provide that the purchase of a life estate
interest in a residential real property by a person aged 55
or over is not a "change of ownership" subject to
reassessment for property tax purposes, when the life
estate interest consists solely of the person's right to
occupy the property as his or her dwelling and does not
include any right to sell or otherwise transfer that
interest.
BACKGROUND
Interests in Real Property
California law distinguishes between freehold estates and
estates less than freehold (leasehold estates). Freehold
estates, such as fee simple and life estates, have a
duration which is not fixed or ascertained. In contrast,
leasehold estates are limited in duration and may be set
for a term of years, as in a fixed term lease, or may be
set from period to period, as in a periodic month-to-month
tenancy.
The quality of interest between a freehold estate and a
leasehold estate also differs significantly. (Civil Code
Section 761 et seq.)
(more)
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Most real estate is purchased in fee simple, meaning that
the person buying the property is buying the entire and
absolute interest in the property. The buyer has the right
to occupy the property, the right to use it in anyway he or
she chooses, and the right to sell the property or transfer
it to others in a will or by inheritance. There is no
form of property ownership greater than a fee simple-it is
the most complete property interest available.
A life estate interest in real property is also a freehold
estate, but it is lesser in duration than a fee simple.
One key distinction is that a life estate terminates upon
the death of a named person, who is usually, although not
necessarily, the person receiving the property interest.
Because life estate tenants own the property only until
their death, a remainder interest is necessary to establish
who receives the property upon the life estate tenant's
death. When combined, the interest of the life estate
holder and the remainderman constitute an estate in fee
simple.
Life estate holders generally have the same rights and
obligations to use the property as people holding fee
simples. However, because there is someone standing to
receive the property upon the death of the life estate
holder, the life estate tenant is not permitted to commit
waste of the property, or do anything intentionally to
reduce its value for the future owner of the property.
Like owners in fee simple, life estate holders may transfer
their property interest, however the transferred interest
will terminate upon their death. Life estate owners are
obligated to pay property taxes and maintain the property.
The holder of the remainder interest does not have a
present interest in the property, and accordingly has no
right to occupy the property.
Leasehold estates (leases) are significantly different from
freehold estates and are accordingly so classified. These
estates, also called tenancy for years or months, are
generally not considered a form of ownership of property,
but a type of possession of property. In a lease, an
owner/landlord maintains the fee simple (or life estate),
but allows the lessee/tenant person to occupy the land for
an agreed-upon length of time. The owner/landlord is
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generally responsible for paying taxes and maintaining the
property, although the lease agreement may shift that
responsibility to the lessee/tenant. The tenant also has
only the right to occupy the property for the length of
time agreed upon, and generally may not make improvements
without the owner's permission. Any additional rights or
obligations of the tenant are established by the terms of
the lease agreement, including the right of transfer, if
any. A tenant's interest in the property is guaranteed to
last as long as the term established in the lease, so long
as the tenant continues to fulfill his or her lease
obligations, such as paying the rent.
Proposition 13
In 1978, Proposition 13 amended the California Constitution
to change the property tax system from a current value
method to an acquisition value system. Proposition 13 set
the assessed value of real estate at the full cash value of
the 1975-1976 property tax bill and established that real
property values can be reappraised only when a purchase or
other "change in ownership" occurs. However, "change in
ownership" was not defined.
The Assembly Revenue and Taxation Committee created a task
force to recommend statutory implementation of Proposition
13, including its change of ownership provision. The task
force's goal in defining a change in ownership was to
distill the basic characteristics of a change in ownership
and embody them in a single test to be applied evenhandedly
to distinguish between changes and non-changes. The task
force ultimately concluded that a "change in ownership" is
a transfer with all three of the following characteristics:
It transfers a present interest in real property;
It transfers the beneficial use of the property; and
The property rights transferred are substantially
equivalent in value to the value of the fee interest.
This test is now embodied in Section 60 of the Revenue and
Taxation Code.
CHANGES TO EXISTING LAW
Existing law provides that the value of property shall be
reassessed when there is a change of ownership.
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Existing law provides that a change of ownership is a
transfer of present interest in real property, including
the beneficial use thereof, the value of which is
substantially equal to the value of the fee interest.
Existing case law provides that the transfer of a life
estate constitutes a change in ownership and the property
is subject to reassessment for tax purposes. [Leckie v.
County of Orange (1998) Cal. App. 4th 334.]
This bill would provide that the purchase of a life estate
interest in residential real property by a person aged 55
or older does not constitute a change of ownership and is
not subject to reassessment for tax purposes when both of
the following apply:
1) the purchaser does not hold a reversionary interest in
the property; and
2) the life estate interest consists solely of the
purchaser's right to occupy the
property as his or her dwelling for a period up to that
person's date of death, and does not include any right to
sell or otherwise transfer that interest.
This bill would include legislative findings that such a
purchase does not constitute a change in ownership because
the value transferred is not substantially equal to the
value of a fee interest in the property.
COMMENT
1. Stated need for the bill
A senior community in Dana Point, California is owned by
a development company. The development company sells
life estate interests to seniors and maintains the
remainder interest in the property. Accordingly, when
the senior life estate holder dies, the property reverts
to the development company and another life estate in the
property can be sold to another senior. After purchasing
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life estates in the property, several of the residents
were sent supplemental tax bills when their property was
reassessed because a change of ownership occurred. They
disputed the tax bills and lost. On appeal, they won.
In San Diego County, the same thing occurred, but those
life tenants did not win their appeal.
The author contends that statutory authority is needed to
ensure that seniors in this situation are not required to
pay tax on the reassessed value of their property. The
author maintains that because a person aged 55 or older
is not expected to live 35 more years, the value of a
life estate interest created in that person is equivalent
to a short-term lease. Because Revenue and Taxation Code
Section 62(g) implicitly establishes that a lease of less
than 35 years is not a change of ownership, the author
contends a life estate that is not expected to last 35
years should also not constitute a change in ownership.
The author argues that a life estate purchased by a
person aged 55 or older does not meet the three-pronged
test for "change of ownership" established in Section 60.
Specifically, the author contends that a life estate in
this situation fails the third prong, that its value is
not substantially equivalent to the value of a fee
interest.
2. To reach its goal of preventing a reassessment of
property taxes upon a sale, SB 333 would blur
longstanding distinctions in real property law and create
new, artificial distinctions without legal basis
SB 333 appears to be fundamentally flawed in several
respects. First, the author's attempt to parse the
requirements of Section 60 fails to recognize the
fundamental longstanding distinction between a life
estate and a lease, in general, and between a freehold
estate and a leasehold estate in particular. To reason
that they are similar because both can terminate within
35 years is to reason arbitrarily and in disregard of the
other attributes of the two estates. (See also Comment
3 for further discussion.) Further, the author's
reasoning fails to acknowledge that leases are not
changes in ownership because they do not transfer a
present ownership interest in the property, condition
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number 1 in Section 60; rather, they transfer a right to
exclusive use and possession of the property. Life
estates, in contrast, do transfer a present ownership
interest in the estate.
In addition, SB 333 would essentially create a life
estate in name only, stripped of a key attribute - the
right to transfer the interest. This result also poses
significant risks for the unlucky or unwary investor who
buys a life estate priced upon a 30-year life expectancy,
but who dies after only two years. In that event, the
property would revert back to the grantor - the
development company selling the "life estate" without the
right of transfer. In such a case, in all respects, the
purchaser would be better off with a lease. Committee
staff questions whether such an artificial property
interest should be created.
WOULD SB 333 CREATE A TRAP FOR UNWARY BUYERS?
SB 333 also fails to address foreseeable contingencies,
which can lead to unintended consequences. For example,
life estates may be conveyed in joint tenancy, that is
for the life of the two joint tenants. For senior
communities, husbands and wives, if they buy a life
estate, are likely to purchase one for the joint lives of
the two. Otherwise, if the property is only in the
husband's name, the wife will be ousted from the property
upon the husband's death. SB 333 only provides for a
life estate interest that terminates "on or before that
person's death." These words do not permit a life estate
for the joint lives of a husband and wife.
Another unaddressed foreseeable contingency is what would
happen when the developer sells all of its remainder
interests to a buyer, thus possibly triggering a
reassessment of all parcels sold as a life estate. Under
the bill, the life estate owner could then be responsible
for paying any increased property. (See Comment 5.)
WOULD THIS ASPECT BE ANOTHER TRAP FOR THE UNWARY BUYER?
SB 333 also conditions its applicability upon the
restriction that the purchaser does not hold a
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reversionary interest in the property. Because a life
estate holder cannot, by definition, also hold the
reversionary or remainder interest (if he did he'd own a
fee simple), this condition is superfluous.
3. A life estate is not equivalent to a lease
Although the life estate holder's ownership only lasts as
long as the life of the holder, in most other respects a
life estate is equivalent to a fee simple. It is
complete ownership of the property with all rights and
obligations of such. Because a future interest exists in
the designated remainder, the life estate tenant has an
additional responsibility of not committing waste on the
property or purposely causing its value to decrease. In
contrast, a lease tenant's rights and obligations to the
land are limited to the terms of the lease and vary from
lease to lease. A lease tenant only inherently possesses
the right to occupy the property unless the lease
provides otherwise. The landlord still owns the land and
is responsible for taxes.
4. The genesis of Section 60 and the value equivalence prong
The Assembly Revenue and Taxation Committee task force's
report determined that the value equivalence prong of the
change of ownership test was necessary to decide who is
the primary owner of the property at any given time. A
major purpose of this part of the test was to identify
the primary owner, so that only a transfer by him will be
a change in ownership and when it occurs the whole
property will be reappraised. The task force determined
that if property was subject to a short-term lease, the
landlord owned the primary economic value of the
property. Accordingly, a transfer by the landlord would
be a change in ownership. If, however, the lease was
long term and the lessee controlled the main economic
value of the property, then the lease assignment would
count as the change of ownership. This is now embodied
in Section 62(g) which provides that a landlord's
transfer of his interest in property subject to a lease
of 35 years or more is not a change of ownership.
Thirty-five years was established as the cutoff between
short- and long-term leases because of the practice of
financial institutions to lend on the security of a lease
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of 35 years or more.
The task force also addressed life estates, but focused
on the situation in which an owner keeps a life estate
for herself but transfers the remainder interest to
someone else, such as her children. Thus, the owner/life
estate holder owns the property until her death when the
property automatically transfers to her children. The
task force explained that in a situation like this, where
a life estate is retained by an owner, no change of
ownership occurs for two reasons. First the life estate
tenant has the dominant or primary interest under the
value equivalence element of the general change in
ownership test. Second, there is no transfer of the
present interest in the property until the life estate
tenant dies. This is embodied in Section 62(e). (See
also next comment.)
The converse to this rationale must be applied when an
owner in fee simple sells a life estate to a third
person. In that situation, rather than retaining the
primary interest in the property under the value
equivalency test, the owner divests herself of it,
transferring the life estate to the third party. This is
a crucial difference, as the transferee receives a
present interest in the property, the beneficial use of
the property, and the primary interest under the value
equivalency test. Using this same rationale, the
California Court of Appeal determined that a life estate
created in a 58-year-old constituted a change of
ownership subject to reassessment for tax purposes.
[Leckie v. County of Orange (1998) 65 Cal. App. 4th 334.]
As noted earlier, the author's contention that because
the actuarial life expectancy of a person aged 55 is less
than 35 years, a life estate in a person aged 55 or older
is equivalent to a leasehold interest for a period of
less than 35 years, and therefore should not be a
non-taxable sale, is an artificial distinction without
basis. And, as noted below in Comment 5, that argument
is inconsistent with the existing law's treatment of the
value of a life estate.
The opposition argues that it is inappropriate to create
a tax exemption based on the actuarial life expectancies
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in 2005. What will the life expectancy be in 15 or 20
years? Will this exemption still make sense? More to
the point, the proposed exemption would introduce another
"loophole" in the property tax law and make it more
difficult for local governments to raise the revenue
needed to service its needs.
At its very least, the proposal presents a question of
what is a fair tax policy. If the life estate tenant
beats the odds and lives an additional 50 years instead
of 35 years, that life estate tenant will still own the
property when she is 105. Yet, during that period, other
properties in the community could have been sold and
resold five or six times, and reassessed five or six
times, during that period. This proposed new loophole
would doubtlessly place a greater burden on local
governments.
5. Under this bill, when would a change of ownership occur?
Existing law, Section 62(e), provides that a change of
ownership does not occur when an owner grants himself a
life estate, but gives the remainder to someone else.
The rationale behind this exception is that when the
owner in fee simple gives himself a life estate, no
change has occurred because the owner/life estate tenant
retains the dominant or primary interest under the "value
equivalence" portion of the test for change of ownership.
The change in ownership occurs when the life tenant
dies and the property reverts to the holder of the
remainder. Accordingly, Section 62(e) provides that the
holder of a life estate, no matter what age, possesses
the dominant or primary interest in the property.
In contrast, this bill proposes to add Section 62(p) to
provide that the owner of a life estate, aged 55 or
older, does not possess the dominant to primary interest
in the property. This proposal directly conflicts with
existing law's characterization of the value of life
estates.
This conflict also creates another, more important
problem. Under this bill, a change in ownership would
not occur when a life estate was transferred to a third
party. If no change occurred when the life estate was
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created, the presumed logical result is that no change
would occur when the life estate ends and the property
reverts to the developer. However, that result would be
in direct conflict with Section 62(e). Moreover, that
conclusion has the further result of the property
potentially never being reassessed no matter how many
life estates are granted and terminated through the
years. Is this a just and appropriate result?
Opposition contends this is a windfall for developers
encouraging a gamesmanship approach to property transfers
to avoid reassessment.
If indeed, as provided by SB 333, that the purchase of
the life estate was not a change in ownership because the
life estate tenant does not possess the primary interest
of the property, then, by necessity, the development
company must possess the primary interest. Accordingly,
when the development company sold their remainder
interest to another company or developer, this would
constitute a "change of ownership" triggering a
reassessment of the properties for tax purposes. Because
the life estate holders are responsible for paying taxes,
is it appropriate to have the actions of the holder of
the remainder dictate when property is reassessed?
6. Base year value transfer provides some protection for
seniors
Proposition 60 amended the California Constitution to
provide that people aged 55 or older may transfer the
base year value of their residence to a new residence of
equal or lesser value. For example, a person who owned a
home worth $500,000, but had only a base year value of
$100,000, could purchase property worth up to $500,000
and transfer the base year value of their former
residence to the new home. Thus, the person would only
be liable for a tax bill on property worth $100,000.
Seniors purchasing life estates in residences are
eligible for this base year value transfer just as if
they had purchased the property in fee simple.
This tax benefit was designed to encourage seniors to
"move down" and does not apply if the new property
purchased is valued higher than the property sold.
Additionally, the transfer is only guaranteed if the old
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and new property is located in the same county. Counties
are authorized to accept transfers from other counties,
but only a few counties have chosen to do so. Notably,
Dana Point is in Orange County, which does recognize
out-of-county base year value transfers.
DOES NOT EXISTING LAW ALREADY PROVIDE FAIR PROPERTY TAX
RELEIF FOR SENIORS?
7. Should public policy be encouraging the purchase of risky
life estates by dangling the carrot of Property 13 tax
avoidance?
The purchase of a life estate is a gamble. Presumably
the price is set by the expected length of life of the
purchaser. However, there is no guarantee that a person
is going to live as long as they might hope.
Accordingly, a person who expects to live 35 years but
dies after 2 years doesn't get her money back for the 33
years she didn't live to own the property. If a tax
incentive is given to seniors purchasing life estates,
especially one like this that seems to prevent the
property from ever being reassessed, life estates will
become more and more popular. Given the risk associated,
are these types of estates really something to encourage?
Because a person's interest in property under a lease or
a fee simple survives the person's death, the estate has
an opportunity to recoup some of the cost expended by the
purchaser. The leasehold interest or fee simple could
also be devised to children or sold by the estate for
partial reimbursement.
8. This bill is limited to life estate interests in which
the life estate tenant does not have the right to sell
the property
This bill applies to life estate interests which do "not
include any right to sell or otherwise transfer that
interest." Normally life estates do not include this
restriction on alienability. It is unclear whether this
provision of the bill stems from a fundamental
misunderstanding of the characteristics of life estates
or whether the life estates in Dana Point were restricted
in this way. In any event, if this restriction is
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intentional, it still does not alleviate the substantial
concerns addressed in Comments 2 through 7.
Support: None Known
Opposition: California Assessors' Association
HISTORY
Source: Author
Related Pending Legislation: None Known
Prior Legislation: None Known
Prior Vote: Senate Rev. and Tax. (5 Ayes, 0 Noes)
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