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Join Us for a Complimentary Webinar on Prop 19

Thursday, December 3rd | 10:30 - 11:30am

Hosted by David Newson, Judith Gordon, and Michelle Soto

Agenda

  • Review the current rules
  • Discuss key changes from Prop 19
  • Provide case studies to help explain its impact
  • Identify potential strategies moving forward

September 14, 2020

How Prop 19 Could Affect California Property Tax Exclusions

Please read important disclosures HERE.

The passage of Proposition 19 on the November 3, 2020, ballot will have a significant financial impact on the transfer of real property to one’s heirs and for those homeowners who are over age 55, disabled, or victims of a natural disaster or waste contamination.

Proposition 19 will limit the ability of heirs to keep low property tax payments on inherited property and will also broaden the rules allowing eligible homeowners to take a portion of their property tax base with them when they sell their home and purchase a new one.

Under current law, California property tax is assessed based on the property’s purchase price and the cost of any improvements to the property. Unless a “change of ownership” occurs, the assessed value of real property increases by no more than 2% annually. A change in ownership of California property often causes the property tax to be reassessed at approximately 1% of the current market value, and a 2% yearly cap becomes applicable to subsequent years. There are, however, numerous exceptions to the reassessment provisions.

One popular exclusion from property tax reassessment involves transfers of property from parent to child or child to parent and in certain instances property transfers from grandparent to grandchild. Under current law, the following transfers of real property can be made between parents and children without triggering a tax reassessment:

  1. Principal residence exclusion: Each parent can transfer during their lifetime, or at death, their primary residence (no value limit); and
  2. Lifetime $1 million non-principal residence exclusion: Up to the first $1 million dollars of assessed value of other properties can be excluded (per transferor).

If passed by voters, Prop 19 would significantly affect these parent-child exclusions to limit (1) the types of transfers between parent and child that can be exempted from reassessment; and (2) the amount of the property tax benefit available.

Types of Transfers

To qualify for the principal residence exemption, after transfer, the child would have to use the residence as the child’s own principal residence.

The lifetime $1 million non-principal residence exemption would be eliminated entirely.

Amount of Benefit

If the transfer meets the principal residence requirement, the child’s new assessed value is then determined based on whether the property’s value at the time of transfer is greater than the parent’s assessed value by more than $1 million.

If the value of the property at the time of the transfer exceeds the parent’s assessed value by less than $1 million, then the child takes the parent’s assessed value. If the value of the property at the time of the transfer exceeds the parent’s assessed value by more than $1 million, then the child’s assessed value is the current value of the property less $1 million.

For example;1:

Sally’s Principal Residence:  $6M Fair Market Value, $1M assessed value, current property taxes: $12,000.

Under current law, if Sally dies and leaves the residence to her daughter Holly, Holly’s property taxes continue at $12,000 with annual adjustments regardless of whether Holly moves into the home as her principal residence.

If Proposition 19 is passed and Sally leaves the residence to Holly, there are two possible outcomes:

If Holly moves into the home as her new primary residence, Holly’s property taxes will be computed as follows:

$6,000,000 -$1,000,000= $5,000,000 x 1%= $50,000 in property taxes

If Holly does not move into the home as her new primary residence, Holly’s property taxes will be computed as follows:

$6,000,000 x 1%= $60,000 in property taxes

In addition to the change in the parent child exclusions, Proposition 19 also expands the ability of  eligible homeowners to transfer their tax assessment to a different home of the same or lesser market value, thus allowing them to move to a new home without paying higher property taxes. If Prop 19 is passed,

  1. Eligible homeowners could transfer their tax assessment basis anywhere within the state and the property’s tax assessment basis could also be transferred to a more expensive home with an upward adjustment; and
  2. The number of times that persons over age 55 or with severe disabilities can transfer their tax basis will be increased from one to three.

If Prop 19 is passed, the new parent-child transfer exclusions will be effective as of February 16, 2021, while the base-year-value transfer by persons over 55 will be effective as of April 21, 2021. The additional revenue raised by this measure will be allocated to wildfire agencies and counties.

Consider Gifting Real Property Now

Given that real estate values may be lower due to the economic effects of the coronavirus pandemic and the passage of Prop 19  in the wings, current gifts of highly appreciated California real estate should be seriously considered.

That said, if Prop 19 is passed, individuals will still have other opportunities to transfer real estate in the future. Other reassessment exclusions may apply when real property is held in a legal entity. For example, under current legal entity exclusions, transfers of portions of a legal entity to children can be made without triggering a property tax reassessment.

A change in ownership of the real property owned by the legal entity occurs upon either of the following two transfer events:

  1. When a person through the purchase or other transfer of ownership interests in an entity obtains control of more than 50 percent of the interests in the legal entity. This type of transfer is referred to as a change in control;2 and
  2. A cumulative transfer of more than 50% of the original co-owners’ interests. This type of transfer is referred to as a change in ownership.3

A transfer of partial interests in a legal entity can often result in valuation discounts in determining the fair market value of the transfer for estate and gift tax purposes and leverage the use of the exemption exclusion amounts.

Being informed is key to making the most of your planning options. If you would like to learn more about Proposition 19, please contact your tax professional or your B|O|S advisor.

Footnotes:

1 All numbers are approximations.

2 For more information, see California Revenue and Taxation Code section 64(c).

3 For more information, see California Revenue and Taxation Code section 64(d).

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