Trust Beneficiary’s Transfer Of Right To Income From Real Property May Trigger Property Tax Reassessment
Under California’s Proposition 13, property may be reassessed for property tax purposes under very limited circumstances. One circumstance that can trigger reassessment is a change in ownership. If a property has not changed hands for a significant period of time, reassessment may lead to a dramatic increase in property tax. Three provisions of the California Revenue and Taxation Code help define what constitutes a change in ownership under Proposition 13. Section 61 of the Revenue and Taxation Code contains examples of transactions that do constitute a change of ownership. Section 62 contains examples of transactions that do not constitute a change of ownership. When a transaction does not fall within either Section 61 or Section 62, the third provision, a general definition in California Revenue and Taxation Code Section 60, applies. Section 60 contains a three part definition of the term “change in ownership”: “ a transfer of a present interest in real property,  including the beneficial use thereof,  the value of which is substantially equal to the value of the fee interest.”
In Phelps v. Orange County Assessment Appeals Board No. 1, the California Court of Appeal held that when a trust beneficiary’s right to income from trust property was transferred to the beneficiary’s children, that transfer constituted a change of ownership for purposes of reassessment under Proposition 13. In Phelps, John Phelps created a testamentary trust. The trust was funded with commercial properties that produced income from rents paid by tenants of the properties. The trust became irrevocable upon Phelps’ death.
One of the assets in the trust was a shopping center. The center’s tenants built their own buildings and were required to maintain them for the duration of their leases. At the end of the lease, the buildings became the property of the trust.
After Phelps’ death his three sons each received, among other things, a one-third in the income generated by the shopping center. After one of the sons died, that son’s interest in the shopping center income was transferred to the son’s four children (Phelps’ grandchildren).
The County Assessor determined that the transfer of the income interest constituted a transfer of ownership that triggered the reassessment of Phelps’ grand children’s interest in the shopping center. The trust challenged the re-assessment. Both the assessment appeals board and the trial court rejected the challenge. The trust sought review by the California Court of Appeal.
In the Phelps decision, the Court of Appeal determined that the transfer to Phelps’ grandchildren of their father’s right to income from the shopping center constituted a change in ownership. The Court found that the first prong of Section 60 was satisfied because the right to own the buildings (built by the tenants) at the end of the leases constituted a present interest in the buildings. The Court also found that the second prong – beneficial use – was satisfied because the right to receive income from property constitutes beneficial use of the property. Finally, the Court found that the grand children’s lifetime interest in receiving income from the property was substantially equal to the value of the fee interest in the property. Because all three prongs of California Revenue and Taxation Code Section 60 were satisfied, the transfer of the income interest to Phelps’ grandchildren constituted a change of ownership that was subject to reassessment for purposes of calculating property tax.