How does the parent-child exclusion work with my business that owns real property in California?

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D. Michael Trainotti - Business/Corporate - Super Lawyers

Answered by: D. Michael Trainotti

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The parent-child exclusion is a policy referring to the transfer of real estate and other property from parents to children. In practice, it means that a parent may pass down property valued at up to $1 million without the child having to pay property tax on it. If you own a business that includes real estate, such as a rental property business, you may wonder if you are able to pass that property (not your residential family home) down to your children under the parent-child exclusion.

The short answer is that it depends on the value of the properties and your existing estate, as well as the type of business entity that you are involved in. The long answer is as follows:

There are two questions that come up with regard to planning your estate here, and both will have an impact on the distribution of property that is a part of your business.

  1. Does your family trust need the typical A-B option?
  2. Do you need your limited partnership (LP) or limited liability company (LLC)?

I can answer both these questions and thereby explain how the parent-child exclusion will work with your business. For the purpose of this question, I am referring only to properties that are not your residence — purely properties owned by your business.

Does your family need the typical A-B trust option?

Depending on how many properties you own and their value, the traditional A-B family trust may not be your best option. This is because if there was no irrevocable B trust established on the death of the first spouse, and the total amount of all the properties were valued at under $1 million, the surviving spouse could simply transfer the properties under the parent-child exclusion and those properties would get a full step up in basis for capital gains tax purposes. This is assuming that the total estate is under the applicable exclusion amount, which is the amount any individual may pass down tax-free. As of 2018, this amount is $11.18 million for an individual.

If, however, the total amount of the properties is valued at $2 million or less, you can get around the $1 million limit of the parent-child exclusion by having an irrevocable marital trust on the death of the first spouse. That means that when the surviving spouse does pass away there are two transferors of the $1 million each. The properties would again, get a full step up in basis for capital gains tax purposes.

So, it depends on the valuation of your properties as to whether a traditional A-B family trust is your best option when considering how you can pass your properties down while minimizing tax.

Do you need your LP or LLC?

It is important to know that if your properties are part of an LP or LLC, you cannot pass them down as part of the parent-child exclusion. Therefore, you may consider a different type of formation, or another way of distributing the properties.

The distribution of property is an important issue in California, where real estate is at a premium. I would suggest speaking to an estate attorney you trust when considering a change to your estate. It is also important to revisit your estate every so often to ensure that it is in line with current tax law.

Disclaimer: The answer is intended to be for informational purposes only. It should not be relied on as legal advice, nor construed as a form of attorney-client relationship.

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