Children inheriting property from their parents will face significant financial consequences once California Proposition 19 (Prop 19) comes into effect on February 16, 2021. California voters approved Prop 19 on November 3, 2020, through the Home Protection for Seniors, Severely Disabled, Families, and Victims of Wildfire or Natural Disasters Act. The law has two major updates:
- It limits the conditions under which parents can transfer their real property to their children without triggering a value reassessment.
- It expands how homeowners over 55 years of age, disabled individuals, and victims of natural disasters can preserve and transfer the assessed value of their primary residence to a replacement residence.
This article focuses on the first aspect of Prop 19. To help you better understand what to expect, we’re breaking down what Prop 19 is and why it’s such a big deal for parents who intend to transfer their homes and other real property to their children.
What Is California Proposition 19?
Prop 19 is potentially the largest property tax hike in California’s history. It wipes out Proposition 13, which was a 1978 law that aimed to limit property taxes, and revokes the long-standing tax benefits of Proposition 58 (1986) and Proposition 193 (1996).
Under Proposition 13, which has been in effect for over 40 years, California properties were taxed based on their assessed value rather than their fair market value. Assessed value includes the purchase price and cost of improvements, plus an increase of no more than 2% per year unless and until there is a change in ownership.
Then there’s Proposition 58, which is referred to as the parent-child exclusion. It excluded reassessment when a parent transferred their primary residence to their children, regardless of its value. It also excluded up to $1 million of the assessed value of other property, such as investment properties, vacation homes, and other secondary residences. It effectively allowed parents to transfer their property tax basis to their heirs. Proposition 193 is similar in that it extended the exclusion to transfers from grandparents to grandchildren.
Unfortunately for families with property assets, Proposition 19 is going to greatly limit the scope of the parent-child exclusion. First, the ability to transfer up to $1 million of assessed value of secondary properties is completely eliminated. Second, parents can no longer transfer their primary property to their child without reassessment to fair market value. This applies unless:
- The heir uses the property as their primary residence
- The fair market value of that primary residence does not exceed its assessed value by more than $1 million. If the difference exceeds $1 million, the new assessed value will be the fair market value minus $1 million.
That means anyone inheriting property from February 16, 2021, will have to factor in significantly increased annual property taxes. The tax hike will be especially large in areas with high property values, such as the San Francisco Bay Area, Laguna Beach, Newport Beach, and the Orange Coast.
How Prop 19 Changes Estate Planning in California
Under the old system, a property’s fair market value was not reassessed for tax purposes when a parent transferred ownership to their child. The transfer would trigger a reassessment on rental properties or other investment properties passed to heirs, but only if their assessed value crossed that $1 million threshold.
Once Prop 19 comes into effect, family transfers will require full reassessments with some limited exceptions. If a parent or grandparent transfers their home to their kids or grandkids via any means (sale, gift, estate plan, etc.), the property will be reassessed to full market value for annual property tax purposes. If you choose to use your parents’ home as a primary residence, up to $1,000,000 of the reassessed value will be excluded. However, if you choose to use your family home for anything other than a primary residence—like a second home, rental property, or vacation home—there is no $1 million exclusion.
This has huge implications for lots of property owners. Let’s say a parent owns a primary residence and an apartment complex in California. The home has an assessed value of $650,000 and a fair market value of $3.5 million; the apartment complex has an assessed value of $650,000 and a fair market value of $4 million. Even though the two properties have different fair market values, their property tax liability is the same because they have the same assessed value. The combined annual property tax of both properties with a property tax rate of 1.25% is $16,250.
Before Prop 19: The parent could transfer both properties to his son with no reassessment on the transfer. The home would be transferred to the son regardless of its value because it was his dad’s primary residence, and the assessed value of the apartment complex falls below the $1 million threshold. Therefore, the combined annual property tax would remain $16,250.
After Prop 19: The son’s annual property tax will be adjusted to the reassessed values of the home and apartment complex. The new assessed value of the home is $2.5 million (the fair market value of $3.5 million less $1 million). The new assessed value of the apartment complex is $4 million because that $1 million exemption only applies to transfers of primary residences. The new combined annual property tax will be $81,250. The son must also use his dad’s home as his primary residence or it will be reassessed to the fair market value of $3.5 million, which would increase the combined annual tax for both properties to $93,750.
That $1 million exclusion for primary residences may benefit some, but it’s still a dramatic tax hike. A $1 million threshold is also pretty low for property in California, especially in coastal areas. The descendants of families that bought homes decades ago for modest sums may not be able to afford a tax rate based on the fair market values of those homes. That was the whole point of Prop 13, and later on Propositions 58 and 193.
For more information on how Prop 19 will affect estate planning, check out the California Board of Equalization website to see a comparison chart of the parent-child exclusion pre- and post-Prop 19.
Will Existing Estate Plans Preserve the Prop 13 Property Tax Basis?
Unfortunately, a typical trust will NOT bypass Prop 19. Wills and trusts are essential to avoid probate in California, but they won’t prevent the full reassessment required by Prop 19. The best strategy for parents looking to lock in the parent-child exclusion rules is to transfer the property to their children before February 15, 2021.
Take Urgent Action Before California Prop 19 Takes Effect
A People’s Choice is committed to helping you maximize tax savings in an ever-changing landscape. Prop 19 will significantly change how estate planning in California will work going forward. Contact A People’s Choice today or call 805-648-5540 if you have any questions or concerns about Proposition 19 and your estate plan.
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