Proposition 19 changes the rules for property tax assessment transfers and could affect your estate planning. While the law also gives tax breaks to older property owners and provides relief for wildfire victims, the most sweeping changes will affect property taxes for those inheriting property from their parents. California voters passed Proposition 19 into law in November, and the law goes into effect on February 16, 2021.
Property Tax Breaks for Older Property Owners
More than 40 years ago, California implemented Proposition 13, limiting property taxes to 1% of a home's taxable value based on the year the buyers purchased the home. A home purchased in 1980 with a taxable value of $300,000 pays 1% of that value, or $3,000, in taxes. The 1978 law also limits increases of real property tax to 2% per year, unless reassessed due to sale or transfer, even if the home increases in value dramatically. As a result, it doesn't make financial sense for long-term property owners to sell and buy new homes because they face significantly increased property taxes.
Under current law, homeowners over 55 years old and certain disabled individuals can transfer the taxable value from their current home to a new residence in the same county, if the value of the new home is less than or equal to the value of their old home.
However, under Proposition 19, a homeowner will no longer be limited to the purchase of a new home in the same county, but rather can purchase anywhere in the state of California. Also, the value of the new home can be greater than the value of the previous one—though the increase in value must be added to the old home's transferred assessed value. This change will take effect after April 1, 2021.
Wildfire Victim Relief
Victims of California wildfires also win under Proposition 19. These individuals can transfer their current, limited property tax rates to the purchase of a new home of equal or lesser value. This benefit gives wildfire victims the same new tax breaks as older home buyers.
Limits to Property Tax Inheritance
Probably the most significant change from Proposition 19 relates to transferring real estate property taxes to adult children. Under current law, parents can transfer their lower property tax assessments to their children. This applies to the parent's primary residence (of unlimited value), and up to $1m (assessed value) of other property. Furthermore, the child is not required to claim the inherited property as their personal residence in order to keep the lower property tax assessment.
As of February 15, 2021, Proposition 19 will limit the property tax assessment transfer to only the parent's personal residence (with limitations), and the child will have to claim the inherited property as their personal residence. Furthermore, if the property's current value is more than $1 million over the earlier taxable value, it will trigger a partial property tax reassessment. Children inheriting investment, commercial, or vacation properties will now pay market value property taxes.
Here are some basic examples:
- Parents home has an assessed value (value on their property tax bill) of $300K. Parents die and leave home to their child who plans to live in it. Home has a date of death market value of $1m. Thus, the difference between the assessed value ($300K) and the market value ($1m) is $700K. Child would receive parent's property tax assessment on the original $300K, because the increase value was not more than $1m.
- Parents home has an assessed value (value on their property tax bill) of $300K. Parents die and leave home to their child who plans to live in it. Home has a date of death market value of $1.5m. Thus, the difference between the assessed value ($300K) and the market value ($1.5m) is $1.2m. Because the increase in value was more than the $1m allowance, the property will be partially re-assessed on the additional $200K of appreciation. Thus, the child's new property tax will be based on the original $300K plus the $200K overage = $500K.
Make Plans Before February 2021
If you plan to leave highly appreciated property to your heirs, you may want to consider making the transfer before February 15, 2021, so that they may retain the lower property tax benefits. However, before making such a transfer, you must consider the potential downside of much greater income tax liability (capital gains) should your child sell the property.
If you leave a property to your child at your death, they will receive a new income tax basis in the property based on its market value. However, if you gift the property to them while you are alive, they will be stuck at your basis. Thus, you need to weigh the potential property tax savings of a lifetime transfer against the capital gains income tax savings of inheriting. If a child plans to sell the property within their lifetime, it will often make more sense to inherit the property to lessen the income taxes due on sale, rather than to transfer it to them during life to limit future property tax.
Please also be aware that there are various other advanced estate planning techniques that may be available to help mitigate the effects of Prop 19. These include the creation of irrevocable trusts, LLCs, etc. However, given the newness of this law and the current lack of guidance from the CA Board of Equalization, Franchise Tax Board, County Assessors, etc., many of these advanced techniques are speculative at the moment.
If you have questions about how Proposition 19 will affect your estate and inheritance plans, we can help. Give us a call at 510-527-6774, or send us an email through our contact page.