Do you live in California and own a property that is near or above $1M and you are considering leaving it to your children in your estate? Or do you have investment property that you intend to leave to your children or grandchildren? This proposition affects you!
The Good News - The proposition, which affects those over 55, has made moving your property tax base throughout the state more accessible. Prop 19 also expanded the class of people who could utilize this tax advantage to include those affected by wildfires regardless of age. In addition, you can now transfer property throughout the state not just within your county up to 3 times (an increase from 1 time currently). Under existing law, only homeowners over 55 years of age or certain disabled persons could make use of this benefit.
The Bad News - With the passing of Prop 19 also came some changes to how property tax is valued after death should you decide to pass your residence or investments to your children or grandchildren. Given consistent property value increases in California, this proposition may have a larger impact on your estate planning strategy than you anticipated.
I have invited my colleague, Bob Davis of NAI Capital, a commercial real estate broker, to weigh in on the topic with a little Q & A.
Q. How has Prop 19 changed the exclusions and assessment of property tax values when transferring property from parent-to-child?
A: Proposition 19 was recently approved by the voters and the changes will be effective on February 16, 2021 (for the parent-child exclusions), and April 1, 2021 (for the base year value transfer by persons over 55).
Currently under CA law when a parent transfers ownership of a principal residence to a child the property’s value for tax assessment purposes is not reassessed regardless of how the child uses the property. Prop 19 changes this by requiring that the child use the home as their primary residence and the exclusion is capped at $1M.
This means that property valued above $1M will be assessed for property tax purposes at its current market value.
For example, assume a parent's home has a taxable value of $1,000,000. Because the parent purchased the home many years ago, its value is now $3,000,000. In other words, it has increased by $2,000,000. The new reassessed value if the parent gifts the home to her child will be $2,000,000.
Proposition 19 eliminates the property tax break for investment homes and commercial properties, meaning that heirs who inherit their parents' properties will pay taxes based on market value, which may have a significant impact on cashflow.
Q:How does this impact the parent-child inheritance strategy?
A:The changes could significantly increase the cost to future generations of keeping legacy properties within the family. Now properties that are over $1M in value and are not the primary residence of the child or grandchild will have their value reset to the current property values adjusting the property tax base which in some cases for properties held over many years will cause the cost of keeping those properties to rise. As a result, there may be better investment alternatives than holding onto inherited property.
Q:What can investors do to minimize this impact?
A:I think it’s important to have a meeting with your heirs, estate planning attorney and/or other advisors to review your plans. Often heirs do not want to receive property, especially if they haven’t been involved in the on-going management. If it’s decided that disposition of property may be more appropriate, then this allows time for planning the disposition to maximize value and minimize tax consequences.
You should also prioritize the transferring of any real property to children now while the current rules are in effect, with specific emphasis on highly-appreciated properties (over $1M) so you can leverage the combined benefits of Prop 13 and the parent-child exclusion for maximum effect.
The federal gift tax exemption is currently at the historic high of $11,580,000 in 2020 making it appealing to some high network individuals to transfer and gift property prior to the deadline.
Q:What will happen if I do nothing?
While this may not affect you today, it will be something your heirs will deal with. Or if you have inherited property recently you may wish to seek counsel to ensure the vesting is set up so that it will not trigger an action after the deadline.
For any property that is inherited after February 26th, the county will likely reassess the property values and will increase the property taxes your heirs pay on those properties.
For more information or for advice on your specific situation, please seek out legal counsel. We can help you find a great local attorney too!
**Disclaimer - We are neither an attorney nor an accountant, Please seek advice of counsel as to the legal and tax implications of Proposition 19 on your situation.