California Real Estate Principles Chapter 11: Real Estate Taxation

A change of ownership statement must be filed with the county accessor within how many days of the transfer?

45

benefit assessments

Amount owed by owners of property that is enhanced by the construction or renovation of improvements.

Veteran's Exemption

California war veterans may receive a $4,000 exemption on the full cash value of their homes.

tax deed

Deed issued by the county tax collector when property is sold at public auction because of nonpayment of taxes.

property tax year

Fiscal year for California property tax purposes runs from July 1 to June 30. Taxes charged for that period become a lien on the property on the proceeding January 1

donee

One who makes a gift.

donor

One who makes a gift.

capital gain

Profit earned from the sale of an asset, where the sales price was greater than the adjusted basis.

reassessment event

Sale or other transaction, such as addition of improvements, that triggers a revaluation of property for tax purposes.

basis

The dollar amount that the Internal Revenue Service attributes to an asset for purposes of determining annual depreciation or cost recovery, and gain or loss in the sale of the asset.(See adjusted basis, depreciable basis, original basis)

county accessor

The official responsible for determining property values for ad valorem taxation purposes.

Transfer tax is $.55 per $500 of new money changing hands. It does not include any loan being assumed.

Transfer tax is $.55 per $500 of new money changing hands. It does not include any loan being assumed.

Tax Deferred Exchange

Under Section 1031 of the Internal Revenue Code, some or all of the realized gain from the exchange of property may not need to be immediately recognized for tax purposes. Both properties in an exchange must be held for productive use in trade or business or for investment and must be of a like-kind. (See like-kind, realized capital gain)

The second property tax installment is due and delinquent on (a)February 1st; April 10th. (b)November 1st; December 10th. (c)December 31st; June 30th. (d)March 1st; July 1st.

You must know the fiscal tax year for the state exam.Memorization Aid: No, Darn, Foolin, AroundNovember 1: First installment dueDecember 10, 5 PM: Delinquent date for 1st installmentFebruary 1: Second installment dueApril 10, 5 PM: Delinquent date for 2nd installment

An owner occupied residence qualifies for a homeowner's exemption of (a)$1,000. (b)$4,000. (c)$7,000. (d)none of these.

Your answer: (C) is correct. An owner-occupied residence, including a condominium or duplex unit, qualifies for a homeowner's exemption of the first $7,000 of full cash value.

The California sales tax is a(n) (a)ad valorem tax. (b)tax paid on real estate. (c)tax paid on tangible personal property. (d)tax paid on all personal proper

Your answer: (C) is correct. The California State Sales Tax is imposed upon retailers for the privilege of selling tangible personal property at retail.

Which of the following is a tax consideration for the homeowner? (a)mortgage interest deductions (b)tax credits (c)capital gains exclusion (d)All of the above

Your answer: (D) is correct. All of the choices above would be tax considerations for the homeowner.

An installment sale represents a tax advantage because (a)it reduces tax rates. (b)it eliminates taxes all together. (c)it is a tax exemption. (d)it defers payment of capital gains.

Your answer: (D) is correct. An installment sale allows the taxpayer to postpone the receipt and reporting of income to future years when his or her other income may be lower. Thus, a taxpayer can avoid paying the entire tax on the gain in the year of sale.

formula for annual taxes

= tax rate X assessed value.

installment sale

An income tax method of reporting gain received from the sale of real estate when the sales price is paid in installments, i.e., where at least one payment is to be received after the close of the taxable year in which the sale occurs. No down payment is required in an installment sale. (See realized capital gains)

Mello-Roos Community Facilities Act

California law that requires property owners benefiting from public improvements financed by bond issues to repay the bonds; requires notification to a prospective purchaser of lien assessments on the property. (See Mello-Roos Bonds)

adjusted gross income

Income from all sources less deductions for taxes, depreciation, and other allowable deductions.

ordinary income

Income that does not qualify for capital gains treatment.

taxable income

Income that remains after allowed deductions from adjusted gross income.

ad valorem

The Latin phrase for "according to value." (See value)

assessed value

The dollar value of an asset assigned by a public tax assessor for the purposes of taxation.

gift

Voluntary transfer by an individual of any type of property for less than full consideration

deductions

amounts on which income tax need not be paid; the home mortgage interest deduction from taxable income benefits homeowners

Tax Cuts and Jobs Act of 2017

law passed in 2017 that significantly modified the tax code. It reduced tax rates for individuals and businesses, increased the standard deductions, and eliminated or reduced common itemized reductions.

Property that is exempt from taxation

-intangible property (such as stocks and promissory notes); -personal property and household furnishings of individuals; -property owned by a government, unless the property is outside the jurisdiction of the public entity and was taxable before acquisition, or it is new construction replacing property that was taxable when acquired; -property used exclusively for religious, charitable, or hospital purposes; and -property owned by nonprofit organizations, such as private schools and colleges.

Morgan Property Taxpayer's Bill of Rights

A California law effective January 1, 1994, that ensures that taxpayers are provided fair and understandable explanations of their rights and duties with respect to property taxation, prompt resolution of legitimate questions and appeals regarding their property taxes, and prompt corrections when errors have occurred in property tax assessments.

use tax

A charge imposed on the use or possession of personal property. Governments employ use taxes to accomplish two purposes. A use tax may be imposed to prevent someone from evading a sales tax by buying goods in a nontaxing state. Use taxes are also used to help defray the cost of public services associated with particular types of personal property.

gift tax

A federal tax applied to an individual giving anything of value to another person. It is the giver of the gift who is required to pay the gift tax. The receiver of the gift may pay the gift tax, or a percentage of it, if giver has exceeded his/her annual personal gift tax deduction limit. California's gift tax was repealed by voters in 1982. (See gift)

capital asset

A long-term asset that is not bought or sold in the regular course of business.

straight line method

A method of depreciation, also called the age-life method, that is computed by dividing the adjusted basis of a property by the number of years of estimated remaining useful life. (See adjusted basis, depreciation)

sales tax

A tax imposed by the government at the point of sale on retail goods and services. It is collected by the retailer and passed on to the state.

special assessment

A tax or levy customarily imposed against only those specific parcels of realty that will benefit from a proposed public improvement, as opposed to a general tax on the entire community. Common examples of special assessments are water, sidewalk and sewer assessments.

proposition 13

A voter initiative that added Article XIII A to the California Constitution. It limits property tax rates to no more than 1% of full cash value. Increases in assessed value per year are capped at 2% or the percentage growth in the Consumer Price Index (CPI), whichever is less. The increase has been less than the 2% cap only five times since 1977.

inheritance tax

An "estate" tax imposed by the state on heirs for their right to inherit property. The tax is not levied on the property itself, but rather on the heirs for their right to acquire the property by succession or devise. Therefore, the rates or the deductions may vary depending on the degree of the relationship.

tax credit

An amount by which tax owed is reduced directly.

homeowner's exemption

An amount of property value of owner-occupied residence excluded from property taxation.

EXERCISE 11-2: A married couple is considering purchase of a Folsom house as their principal residence. They never have owned a home and are not sure they can afford one. Their combined gross income is $9,800 per month. They have saved $145,000 and have no outstanding debts. The rent on their present two-bedroom, two-bath apartment is $1,875 per month, and they pay utility bills of $186 per month, averaged over the year. They anticipate yearly rent increases of 5%. Their landlord is holding their security deposit of $1,655. The three-bedroom, two-bathroom Folsom house could be purchased for $575,000, requiring a down payment of $115,000 and monthly principal and interest payments of $2,757.93 on a loan of $460,000, with a 6% fixed interest rate and a 30-year term. During the first year of the loan, only $5,648.85 in principal would be paid; in the fifth year, $7,176.81 in principal would be paid. The yearly property tax bill would be $5,865, and annual fire insurance would be $1,400. The sellers have paid utility bills averaging $225 per month, and the purchasers use that figure. What are the purchasers' present and anticipated total apartment rental expenses before taxes? After taxes, assuming a 28% tax rate? In five years? What would be the purchasers' total monthly expenses as homeowners, before taxes? After taxes, assuming a 28% tax rate? In five years? What other factors should the purchasers take into account in determining the financial advantages and disadvantages of home ownership?

Answer: The purchasers' present rental expenses are $2,061 per month ($1,875 rent plus $186 utilities). In the fifth year they will be paying a total of $2,465.08, assuming a 5% increase per year and no increase in utility payments, and will start the sixth year at $2,579.03 per month. They will receive no tax break on the rental expenses. As homeowners, the couple will have monthly expenses of $3,588.35 ($2,757.93 mortgage payment plus $488.75 as one month's share of the property tax plus $116.67 as one month's share of fire insurance plus $225 for utilities) before taxes. After taxes, taking into account that they will be paying $27,446.34 in interest and $5,865 in property tax the first year, their payment is effectively $2,811.09 ($27,446.34 interest + $5,865 property tax = $33,311.34 tax deductions; $33,311.34 X 28% tax rate = $9,327.18 by which the couple's taxes will be reduced; $9,327.18 / 12 = $777.26 monthly tax benefit; $3,588.35 - $777.26 = $2,811.09 effective monthly housing expense).In five years, when a greater share of the couple's mortgage payment is principal, they will have monthly expenses of $3,588.35 before taxes, and $2,846.74 after taxes. The after-tax amount is calculated as follows: $25,918.38 interest + $5,865 property tax = $31,783.38 tax deductions; $31,783.38 X 28% tax rate = $8,899.35 by which the couple's taxes will be reduced; $8,899.35 / 12 = $741.61 monthly tax benefit; $3,588.35 - $741.61 = $2,846.74 effective monthly housing expense. The couple also should take into account any reduction in their state income tax resulting from mortgage interest and property tax deductions, the possibility that they will move into a higher tax bracket and have a greater benefit from the allowable deductions, the condition of the house (Will it need major repairs in the near future?), the loss of income from the $115,000 used as a down payment, the equity buildup in the house over the loan term, the appreciation (or depreciation) of real estate, the fact that they may not qualify for the loan they want, the fact that as homeowners they will have to cut back on other expenses in the first years of ownership to cover their housing bills, the size of their family and their likely needs in the future, and the housing amenities that they have come to expect or would prefer to have.

Cara and Jose Ortiz have owned their home in Valley Meadow since 1974. The assessor's appraised value of the Ortizes' home in 1975 at the time Proposition 13 went into effect was $62,000, and the Ortizes receive a homeowner's exemption. There are no additional assessments, although there has been an annual increase of 2% in assessed valuation due to inflation. The current assessed value of the Ortizes' home is approximately $119,300. What tax do the Ortizes currently pay? What amount is due in the first installment? What amount will be due if that installment is paid after December 10?

Assessor's appraised value $119,300.00 Less homeowner's exemption $7,000.00 Taxable amount $112,300.00 Tax rate .01 Tax $1,123.00 Installment $561.50 Delinquent payment $617.65

A home in Valley Meadow was purchased on July 1, 2016. The purchase price was $695,000, and the new owner is entitled to a homeowner's exemption. Compute the new owner's first year property tax bill, the amount of each installment, and the amount of the delinquent payment.

Assessor's appraised value $695,000Less homeowner's exemption 7,000Taxable amount 688,000Tax rate .01Tax $6,880Installment $3,440Delinquent payment $3,784

C and J have owned their home in Valley Meadow since 1974. The assessor's appraised value of the home in 1975 at the time Proposition 13 went into effect was $62,000, and C and J receive a homeowner's exemption. There are no additional assessments, although there has been an annual increase of 2% in assessed valuation due to inflation. C and J also increased their assessed valuation by remodeling their home to add an extra bedroom and bath. The current assessed value of the home is approximately $179,300. What tax do the homeowners currently pay? What amount is due in the first installment? What amount will be due if that installment is paid after December 10?

Base value $360,871.00 Less homeowner's exemption $7,000.00 Taxable amount $353.871.00 Tax rate .01 Tax $3,538.71 Installment $1,769.36 Delinquent payment $1,946.29

FOR EXAMPLE: A homeowner is about to close on the sale of his home. After paying sale expenses, he will receive $125,000 in cash from the equity in his home. If the seller takes the $125,000 cash and places the funds in a five-year U.S. Treasury note, he will receive 2.5% annual interest on his money, or $3,725, which will be compounded (added to principal each year). Instead, the seller may decide to lend the buyers of the home the $125,000 by taking a second trust deed and accepting payments that include interest of 4.5%, the same rate the buyers are paying to the lender on the first deed of trust. If the seller accepts payments of interest only, he will receive interest income of $5,625 per year ($125,000 × 4.5%), or $468.75 per month ($5,625 ÷ 12). The seller could then place the interest income in a savings or money market account and receive future interest on that money as well.

FOR EXAMPLE: A homeowner is about to close on the sale of his home. After paying sale expenses, he will receive $125,000 in cash from the equity in his home. If the seller takes the $125,000 cash and places the funds in a five-year U.S. Treasury note, he will receive 2.5% annual interest on his money, or $3,725, which will be compounded (added to principal each year). Instead, the seller may decide to lend the buyers of the home the $125,000 by taking a second trust deed and accepting payments that include interest of 4.5%, the same rate the buyers are paying to the lender on the first deed of trust. If the seller accepts payments of interest only, he will receive interest income of $5,625 per year ($125,000 × 4.5%), or $468.75 per month ($5,625 ÷ 12). The seller could then place the interest income in a savings or money market account and receive future interest on that money as well.

base value

For property tax assessment purposes, the full cash value of a parcel of real estate as of February 28, 1975, or the date of a subsequent sale or other reassessment event.

change in ownership statement

For property tax purposes, a change in ownership in real property is the transfer of a present interest in real property, including the transfer of the rights to the beneficial use thereof, the value of which is substantially equal to the value of the fee interest.

FOR EXAMPLE: The X decide to add a few rooms to their home. They get a building permit for their planned addition of 1,500 square feet and hire a contractor. While the work is under way, an appraiser from the assessor's office comes by to look at the extent of the property improvement. When the work is finished, the appraiser comes by again, but the Xs refuse to allow the appraiser to see the finished improvement. Judging from the outside of the property the appraiser estimates that the finished addition is 2,100 square feet. Based on that estimate, the property is reassessed and the Xs' property tax bill increased accordingly. The Xs then appeal the assessment, claiming that the finished addition is no more than 1,650 square feet and the assessment should be reduced to reflect that fact.

In this case, the court held that the assessor's estimate is the only reasonable basis on which the reassessment can be made. The Xs' statement of the square footage of the addition is self-serving and, therefore, cannot serve as the basis for reassessment. The Xs cannot complain that the estimate is inexact because they themselves refused the assessor's appraiser access to the property.

certificate of redemption

Issued by the county tax collector when all past due amounts have been paid.

boot

Money or other property that is not like-kind, which is given to make up any difference in value or equity between exchanged properties. Boot may be in the form of cash, notes, gems, the market value of an asset such as a mortgage, land contract, personal property, goodwill, a service or a patent offered in an exchange. (See exchange, like-kind)

FOR EXAMPLE: Penelope Pilot owns her home, for which she paid $372,000, and has occupied it as her principal residence for seven years. If Penelope sells her home for $595,000, must she pay any federal income tax on her profit?

No. Penelope's profit of $223,000 (which will be even lower after it is reduced by expenses of sale, such as a real estate commission) is less than the $250,000 profit she is allowed to receive free from federal income tax.

recovery property

Property that can be depreciated for income tax purposes, with the cost of the property deducted from income over a stated period.

proposition 60

Proposition 60 provides that homeowners older than age 55 who buy or build another residence within the same county can transfer the assessed value of the previous residence to the new residence. Proposition 90 provides that homeowners older than age 55 may transfer assessed value to a new residence in another county, if allowed by the new county.

proposition 90

Proposition 90 provides that homeowners older than age 55 may transfer assessed value to a new residence in another county, if allowed by the new county.

documentary transfer tax

Tax applicable to property transfers and affixed to the grant deed; varies from county to county, city to city.

tax bracket

Tax rate applicable to a taxpayer's taxable income.

depreciation

The decrease in the value of an asset when computing property value for tax purposes. It can also be a loss in the appraised value due to physical deterioration. The latter type of depreciation is curable when it can be remedied by repair or addition to the property, and incurable when there is no economical remedy. (See appreciation)

An investor purchased an apartment building for $7,500,000. The land is valued at $800,000 and the improvements are valued at $6,700,000. What is the amount of the yearly depreciation deduction available to the investor?

The depreciation deduction is $243,636 per year ($6,700,000 ÷ 27.5).

FOR EXAMPLE: An investor exchanged her eight-unit apartment building for a six-store strip shopping center owned by the River Valley Trust. Both properties were owned free and clear, but the investor paid $500,000 in cash in addition to turning over the deed to the apartment building. Disregarding any commission or other expenses of sale, what is the tax impact of the transaction for each party?

The investor's tax basis in her new property is the tax basis of her old property, plus $500,000. She owes no tax on the transaction. The trust's tax basis in its new property is the tax basis of its old property if the trust's gain is greater than $500,000. In addition, the trust will be taxed on the $500,000 in boot that it received as part of the transaction.

adjusted cost basis

The original cost basis of a property reduced by certain deductions and increased by certain improvement costs. The original basis determined at the time of acquisition is reduced by the amount of allowable depreciation or depletion allowances taken by the taxpayer, and by the amount of any uncompensated property losses suffered by the taxpayer.

tax rate

The tax rate for each taxing body is computed separately. To arrive at a tax rate, the total monies needed for the coming fiscal year are divided by the total assessments of all real estate located within the taxing body's jurisdiction.

The maximum nontaxable amount that can be given as a gift to one donee, in one year, is currently (a)$15,000. (b)$10,000. (c)$5,000. (d)$1,000.

Your answer: (A) is correct. A gift is a voluntary transfer by an individual of any type of property for less than full consideration. The giver is the donor; the recipient of the gift is the donee. No gift tax return need be made on a gift to one donee, in one year, of a present interest valued, as of 2019, at $15,000 or less. (A married couple could give $15,000 each, for a total of $30,000 to one donee in one year.) For every year after that, the maximum gift allowed before a gift tax return must be made will be $14,000 per donee plus an adjustment for inflation, although the exclusion will remain at $14,000 for 2014. If the gift is a future interest, a return always must be made.

Which of the following is considered an ad valorem tax? (a)real property tax. (b)unit tax. (c)use tax. (d)death tax.

Your answer: (A) is correct. Real estate taxes are assessed according to the value of the property taxed (ad valorem).

If Johnson's intent is to accomplish a "tax free" exchange of his apartment building, he should exchange for (a)another apartment building. (b)a personal residence. (c)a second home. (d)an owner-occupied, single-family residence

Your answer: (A) is correct. To be a tax-deferred exchange, as defined in Section 1031 of the Internal Revenue Code, the properties exchanged must be of like kind in nature or character. Most real property can be exchanged for other real property, such as an office building for vacant land. Property held for personal use cannot be exchanged for investment property; for example, a personal residence cannot be exchanged for a house that will be rented.

Tax consequences with respect to real estate should be known (a)prior to acquisition. (b)at time of sale. (c)at close of escrow. (d)three months after taking possession.

Your answer: (A) is correct. Virtually all important decisions affecting tax liability must be made before a transaction in negotiated. At any other time, it may be too late.

If a property owner believes that the assessed value on his or her property has been set too high, the owner could file a request to seek a reduction from the (a)County Board of Supervisors. (b)Assessment Appeals Board. (c)Tax Collector. (d)State Board of Equalization.

Your answer: (B) is correct. Each county has an Assessment Appeals Board to which an individual can question their property's value set by the assessor.

A manufactured (mobile) home can be either personal property or real property. As personal property, a manufactured home is subject to (a)local property taxation. (b)vehicle license fee status. (c)special tax assessment status. (d)supplemental tax status.

Your answer: (B) is correct. Manufactured (mobile) homes can be either personal property or real property. As personal property, a manufactured home is subject to vehicle license fee status. Vehicle license fee status means that title to the manufactured home is registered with the Department of Housing and Community Development (HCD). If treated as real property, a manufactured home is subject to local real property taxation.

Which of the following can a property owner expect after sewer lines are installed in front of his/her property? (a)supplemental assessment (b)general assessment (c)special assessment (d)All of the above

Your answer: (C) is correct. A special assessment is a tax imposed against only those specific parcels of realty that will benefit from a proposed public improvement, as opposed to a general tax on the entire community.

An investor can take advantage of all of the following EXCEPT (a)depreciation. (b)deductions for expenses of operation. (c)homeowner's exemption from federal income tax. (d)deduction of rental property losses

Your answer: (C) is correct. An investor cannot take advantage of the homeowner's exemption from federal income taxation but receives other benefits of property ownership.

A buyer does not have to withhold a portion of the sales price from a seller when (a)the property is residential. (b)the seller refuses to pay the withholding. (c)the sales price does not exceed $100,000. (d)None of the above

Your answer: (C) is correct. California Withholding on the Sale of Real Property: Effective January 1, 2003, buyers must withhold and transmit a portion of the sales price to the Franchise Tax Board (FTB) regardless of whether the seller is a California resident, unless an exemption applies. Buyers must withhold 3 1/3 percent of the gross sales price on sales of California real property interests when:1) the seller is an individual (a "natural person") (Rev. & Tax Code SS 18662(e)(1)); or2) the seller is not an individual and the funds will be transferred to a seller with a last known street address outside of California or to the seller's financial intermediary. (Rev. & Tax Code SS 18662(f)(1)). The exemptions for individuals selling real property include the sale of property for less than $100,000, the sale of a principal residence, an IRC SS 1031 exchange, an involuntary conversion under IRC SS 1033, and the sale of property at a loss for California income tax purposes.

A way to spread the cost of acquiring property used in a trade or business over its useful life that is a deduction from adjusted gross income describes (a)reconciliation. (b)recuperation. (c)depreciation. (d)deferred maintenance.

Your answer: (C) is correct. Depreciation is an expense deduction taken for an investment in depreciable property to allow for the recovery of the cost of the investment. The annual amount of the depreciation deduction results from an arbitrary apportionment of the investment in the building systematically spread over its useful life.

Tax delinquent residential real property not redeemed by the owner during the five year statutory redemption period is deeded to the (a)city. (b)county. (c)state. (d)school district.

Your answer: (C) is correct. If the property is not redeemed by the owner during this statutory redemption period, the property is deeded to the state.

In computing transfer tax, the consideration paid for the property excludes (a)the down payment. (b)the deposit. (c)any preexisting liens or encumbrances. (d)any property taxes due.

Your answer: (C) is correct. In computing transfer tax, the consideration paid for the property excludes any preexisting liens or encumbrances that were not removed by the sale (such as an assumed loan).

Real property taxes become a lien on (a)November 1st. (b)February 1st. (c)January 1st. (d)July 1st.

Your answer: (C) is correct. The next tax year's real property taxes become a lien on January 1st.

Recognizing that many older people on fixed incomes have trouble paying property taxes, the Property Tax Postponement Law was passed to allow (a)senior citizens to postpone payment of property taxes. (b)blind or disabled people to postpone payment of property taxes. (c)both (a) and (b) are correct. (d)certain individuals to postpone property taxes on houseboats and floating homes.

Your answer: (C) is correct. The state recognizes that many older people on fixed incomes are property owners but have little funds to set aside for taxes. The Property Tax Postponement Law allows a senior citizen (person aged 62 or older) to postpone payment of taxes on his or her personal residence. Postponement also may be made by persons who are blind or disabled, as defined in the law. If the applicant is married, only one spouse need qualify. Houseboats and floating homes on which the property taxes are delinquent at the time of application are not eligible for postponement.

Which of the following is true regarding current federal estate tax law? (a)The Tax Cuts and Jobs Act of 2017 (TCJA) established a federal estate tax exemption of $11.18 million per person, indexed for inflation. (b)) The estate is taxed at a 40% rate on any estate value over that amount. (c)The exemption was $11.18 million for 2018 and $11.4 million for 2019. (d)All of the above

Your answer: (D) is correct. The Tax Cuts and Jobs Act of 2017 (TCJA) established a federal estate tax exemption of $11.18 million per person, indexed for inflation. The estate is taxed at a 40% rate on any estate value over that amount. The exemption was $11.18 million for 2018 and is $11.4 million for 2019.The exemption is reduced by any large gifts (those subject to gift tax) made during the decedent's lifetime.