Under California Proposition 13, each County in California collects an annual real property ad valorem tax not to exceed 1% based of the value at time of the purchase with annual increases restricted to an inflation factor not to exceed 2% per year.
As the rate of return of real property tends to grow faster than the 2% cap, over time the lower tax base becomes a valuable asset.
Proposition 13 disincentivizes sales in instances where the assessment value is lower than the market value. This is because selling and purchasing a comparable real property at the same price point would result in a significantly higher annual assessment.
For individual real property owners, there is a reassessment exemption for a transfer to a child. In addition, those age 55 or older can transport the preexisting proposition 13 rate to a new property of equal of lesser value. Only certain counties participate in the age 55 and older scheme. For non-residential property, each person has a one million dollar exemption. Anything in excess will result in a partial reassessment. For residential property there is no dollar limit, but only one property can qualify as such.
For real property held and owned by a legal entity (e.g. LLC), a change of majority control or ownership results in a reassessment. This has encouraged fractionalized ownership where no one person owes more than 50%.
Assuming real property values exceed 2% growth over time, Proposition 13 has an elevated impact for long-term investors who need to be extra cautious when structuring ownership and title upon acquisition, and prior to lifetime dispositions and death. Failure to do so can result in otherwise avoidable partial or total reassessment.