While we commonly hear “buyer beware” when someone buys real property, “seller beware” might be the better warning when giving someone an option to buy real property.
Generally, giving an option to purchase property does not result in a reassessment of the property for property taxes. Under Prop 13, property taxes don’t change much until a change in ownership. An option only gives the person to whom the option is granted (the “optionee”) a right, but does not impose an obligation, to purchase.
With an option, title does not change unless and until the optionee exercises it and buys the real property. Only then are property taxes of concern. So generally, you don’t have to worry about property taxes skyrocketing when you give someone an option to buy your real property.
But the devil’s in the details. If the county assessor determines the optionee is "economically compelled" to complete the purchase, that’s a different story: Property taxes might be re-assessed.
Further, if the assessor finds that, at the time that option is granted, "significant equity" is present or "equity will be established with certainty within a short period, property may be reassessed increasing property taxes. If the selling price in the option agreement is significantly less than the market value, for example, the assessor may determine that "significant equity" is present at the time the option is granted, and the option is really a type of a sales agreement, triggering reassessment.
Lease options can also trigger reassessment upon the granting of the option. For example, if a tenant has the option to purchase property at the end of a lease term, and the lease payments are significantly higher than market rent, the tenant may be considered “economically compelled” to buy the property to avoid forfeiture of the above-market rent paid during the lease term. Such an option to buy, in the assessor’s eyes, may give the tenant significant equity in the property. In other words, the assessor may consider the above-market rent defacto equity since the sale will inevitably happen. Such an option, a type of sales agreement, may trigger reassessment at the granting of the option.
If you grant someone an option to purchase your real property, asking two questions could affect your pocketbook:Does the granting of the option "economically compel" the person to exercise the option?Will equity be established at the granting of the option or within a short period afterwards?
If the answers are “yes” to either question, the mere granting of the option may result in re-assessment and higher property taxes.
Owners cannot have their cake and eat it too. They can’t get the proceeds that a sale would garner (in the form of above-market rent upon the granting of the option)) and keep their low Prop 13 property taxes as if the property had not been sold.
Bottom line: Although typically granting an option will not trigger reassessment, since Proposition 13 is sacred for real estate owners, understand the exceptions to the rule before you grant someone an option to buy your real property. If you are considering granting someone an option to purchase your property, “Seller Beware.” ...
Attorney Michelle C. Lerman’s about-to-be-released book Create Your Best Legacy contains up-to-date strategies for homeowners, real estate investors and parents to protect their assets and pass on their wealth, without needless fees and delay. A frequent guest on radio and TV, attorney Ms. Lerman is certified by the California State Bar Board of Legal Specialization as a Legal Specialist in Estate Planning, Trust and Probate Law and is a 2008 and 2009 Super Lawyer. She co-founded Lerman Law Partners LLP with her husband of 32 years, Jeffrey H. Lerman, past president of the Marin County Bar Association. She can be reached by email at email@example.com.