Proposition 19, which is a new law in California passed by the voters November 3, 2020, significantly changes the way property taxes are calculated when there is a transfer of California real estate between parents and children (and, in some cases, between grandparents and grandchildren). With few exceptions, the law will cause the new owner to have the property assessed and be subject to a significantly increased property tax burden. Prop 19 goes into effect on February 16, 2021, leaving little time to act. What follows outlines the changes to help you consider whether you might want to take immediate action.
Who should be concerned?
Anyone who hopes to pass California real estate on to their family is impacted by Prop 19. You should be especially concerned if: you are a long-time owner of California property that has increased substantially in value; you own commercial or investment property in California; you have a family cabin or vacation home in California; you believe your children and/or grandchildren will want to keep your California real estate rather than sell it.
How are California property taxes calculated?
In order to understand what Prop 19 does, it is important to understand the current rules.
California property taxes are calculated as a percentage of the purchase price and cannot increase more than 2% per year. However, the fair market value of California real estate has historically increased at a rate far exceeding 2% per year. This means that for long-time owners, actual fair market value is likely MUCH higher than the tax assessed value.
Whenever there is a change in ownership, the property is subject to reassessment, bringing the tax assessed value in line with then-current fair market value of the property. This means that a new owner is likely to be paying significantly more in property taxes on the same property than the previous owner.
Consider a property that was purchased for $200,000 in 1980; the fair market value of the property in 2020 is $2M. Assuming a 2% increase in property tax annually, the original owner is paying less than $4,000/year in taxes. But a new owner who purchases the property for $2M, would be paying $20,000/year in property taxes – that’s $16,000 more per year!
What does Prop 19 do?
Certain changes in ownership have historically been exempt from reassessment – and this is where Prop 19 causes problems.
Since 1986, there has been a reassessment exclusion for transfers of a primary residence between parents and children, meaning that parents can pass on their tax base to their children (or vice versa), potentially resulting in significant property tax savings for the new owner. In addition, parents could each pass an additional $1M of other real property (for example, an investment property) to their children without triggering reassessment.
As of February 16, 2021, however, the parent-child exemption will be altered by Prop 19. Transfers of a primary residence qualify for the parent-child exclusion ONLY where the property served as the principal residence of the transferor and will also be used as the principal residence of the transferee – so your children must actually move in to your home full-time (within one year of the date of transfer) to preserve the property tax basis. This is very bad news if your children might want to inherit your home and use it as a rental or vacation property.
Furthermore, under Prop. 19 there is a value limit imposed such that only the current tax assessed value + $1M is excluded from reassessment. This again is very bad news if your home has appreciated significantly in value such that it would be subject to partial property tax reassessment, which could be substantial, depending on the extent of appreciation.
Finally, Prop 19 eliminates the ability to pass real property other than the primary residence between parents and children without triggering reassessment. This is a big problem if you have residential or commercial rental property, or a second home or cabin, which you plan to pass on to your kids.
This sounds awful – why would Californians have voted to approve Prop 19?
Prop 19 eviscerates the parent-child property tax reassessment exclusion; however, it does have certain benefits – specifically for persons over the age of 55, disabled homeowners, and disaster victims. These homeowners have always been able to transfer their property tax basis from their original home to a new home under certain circumstances, and under Prop 19, those circumstances have been expanded.
Additionally, it is important to know that Prop 19 was sponsored by the California Association of Realtors because Prop 19 will likely result in increased home sales – either because children cannot afford the property taxes on an inherited property or because of increased mobility for homeowners over age 55, disabled homeowners, or victims displaced by disasters.
What are my options?
There are several ways to preserve your property tax basis for your children (and, in some cases, your grandchildren) using strategic gifting and/or sophisticated planning techniques and ownership entities – but whether a particular strategy is right for you depends upon consideration of many factors in your unique circumstances.
Don’t wait. Call us today at (877) 757-8120 or contact us online (https://evergreenlegacyplanning.com) to schedule a consultation so we can help you develop the best plan for your California real property.