CA Tax: Property Tax Queries

California CPA September 2009

Plus: FTB Collections, Penalties and 1031 Exchanges
By Leonard W. Williams, CPA

A TaxTalk participant recently asked this property tax question: A client owns outright an oil well in Hurlong, Calif. The federal government has a right to purchase this lease for $1. If the government relinquished this right, does that create a re-appraisal for property tax purposes?

Answer: No. An option isn’t a present interest in realty, it doesn’t include the current beneficial use of the property and usually isn’t equal to the value of the fee interest in the property. So it fails all of the main tests of a change in ownership as specified in Revenue and Taxation Code Sec. 60.

With the exception of when an option is a disguised sale, the transfers of options to purchase or lease realty are not in themselves changes in ownership.

Collection Updates
The FTB began mailing 40,000 notices per day (200,000 notices per week) June 1 to taxpayers who either owed money on their 2008 returns or whose 2008 returns were adjusted. The mailing’s later start date was to avoid the problems of prior years when received notices during the filing season for balances due on e-filed returns—although they had until April 15 to pay.

In May, the FTB started collecting on child support dual liability cases. Previously, they only sent an annual notice to taxpayers who also owed a child support obligation and did not pursue collection.

FTB Penalizes Frivolous Submissions
The FTB will begin imposing a $5,000 penalty in response to a specified frivolous submission, pursuant to Revenue and Taxations Code Sec. 19179(d). Taxpayers that are notified they have submitted a “specified frivolous submission” have 30 days to withdraw it in writing. More information is available online. (Search “frivolous submissions.”)

Individuals Do Not Have Standing to Sue for Alleged Sales-tax Breaches
A department store charged sales tax on a to-go cup of coffee, and the customer then sued the store to get a refund for a class of customers that had bought hot coffee to go.

The California Court of Appeals, Second District, held that it’s not allowed for a taxpayer to sue a retailer to get a refund unless the Board of Equalization has determined that the retailer overpaid and is required to repay the customers (Loeffler v Target Corporation).

FTB, Sec. 1031 Exchanges and Property Owned by Trusts
Disposing and replacing rental, business or investment realty by a Sec. 1031 exchange is a common occurrence.

There are variations, such as a delayed, or “Starker,” exchange that have specific requirements that must be fulfilled to be honored by the income tax authorities.
There are other homemade attempts to derive the benefits of Sec. 1031 exchanges in situations for which there is neither statutory nor regulatory guidance.

One common occurrence is when the disposition of a property held in partnership form includes some partners wanting an outright sale and others wanting an exchange.

The proper course of action would be to distribute the property to the partners as tenants-in-common, have them operate it in that form for awhile, then do the sale and exchanges as necessary.

That’s a great theory, but most real estate transactions don’t have enough time to go through all of that. There’s the additional problem that there is no time specified for holding the property as tenants-in-common. Therefore, we see a lot of very short holding periods of the property before executing the exchange.

The FTB has been going after those transactions tooth and nail for some time, and short-term holding periods, followed by an exchange, are referred to as “drop
and drag.”

The FTB reviews almost every Sec. 1031 exchange. About the only ones that go unchallenged are straight, single-owner property exchanged for another property.
A TaxTalk participant asked about the advisability of doing the “distribute, hold and then exchange” route when the property is the sole asset of a trust. Such a transaction would be even more vulnerable to being disallowed by an FTB auditor because the beneficiaries normally do not control the trust. The grantor or decedent’s instructions control it.

SBE Staff Directory Released
The Board of Equalization has issued a staff directory to county assessors that should help tax professionals in the property tax arena. It includes official designations for staff members and their contact information.

Thanks to the following CPAs for their contributions: Jim Bone, Jim Counts and Kip Dillinger. 
Leonard W. Williams, CPA is a Sunnyvale-based sole practitioner, a member of CalCPA’s Committee on Taxation, the AICPA Tax Division and a former Peninsula Chapter president.