Non Pro Rata Distribution of Estates - Intergenerational
California law provides for an intergenerational exclusion from reassessment for transfers between parents and children and, in certain cases, between grandparents and grandchildren. One common form of family transfer is by inheritance when a parent dies and leaves the property to a child(ren). The two most common forms of inheritance, other than by intestate succession where there is no will or other document, are by trust or by will. A pro rata distribution of the assets of an estate means that each heir receives an equal portion of each asset in the estate. A non pro rata distribution means that each heir receives an equal proportion of the entire estate but not necessarily of each asset. Under California law, trustees have non pro rata distribution powers for the assets of a trust. The use of non pro rata distribution by a trustee can have a major impact on the property taxes to be paid by a child or children taking title to the real property in an estate.
Example Number 1
Frances Doe, surviving parent, dies and leaves the family home, which she has owned for 30 years and has a Proposition 13 base year value of $110,000, to her three children. The home is the only asset in the estate and is free of debt. Frances’s will calls for distribution in equal shares, i.e. pro rata, with each child inheriting one-third of the home. The transfer by inheritance from Frances to her three children is covered by the intergenerational exclusion if one of the children moves into the residence and there is no reassessment. After the estate is distributed, Frances’s daughter who moved into the home decides to buy out her two brothers by taking out a new mortgage for two-thirds of the $480,000 current market value of the home. The daughter will keep her mother’s low, Proposition 13 base year value as to one-third of the home’s assessed value. However, the buyout between siblings is not intergenerational and is therefore subject to reassessment. The reassessment will be based on two-thirds of the current market value of the home at the time of the buyout and will add approximately $245,000 in new assessed value, raising the daughter’s tax bill from the mother’s old amount of approximately $1500 per year (including direct charges) to approximately $4100 per year.
Example Number 2
Harold Jones, surviving parent, dies and passes his estate through a trust to his three children in equal shares. The estate, after all expenses are paid, consists of the family home, which he has owned for 30 years and has a Proposition 13 base year value of $150,000 and two CDs in the amount of $600,000 each. His son, Michael, wants the home to become his principal residence and the two daughters each want cash. The trustee does a non pro rata distribution wherein each daughter gets $600,000 in cash and Michael gets the home which is worth $600,000 in today’s market.
Michael is entitled to a complete intergenerational exclusion because the non pro rata trust distribution by the estate is not considered “buying out” his sisters. Michael keeps his father’s Proposition 13 base year value as long as he remains in the home as his principal residence thereby saving approximately $3,200 per year in property taxes.
Trusts can borrow money against the real property to be distributed if there are insufficient other assets in the trust in order to qualify for a non-pro rata distribution. The child who wants the real property takes it subject to the loan. However, the child who takes the real property cannot be the lender because the loan funds are distributed to the siblings which constitutes a sibling buyout.
Estate planning and distribution of estates are complex matters and should be undertaken only with the advice of professionals.