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California Proposition 19: Estate Planning and Property Tax Assessments

By Matthew R. Adams on December 11, 2020
Categories: ESTATE PLANNING, TAXES

Proposition 19 (Prop 19) has created a major change in how real estate assets can be passed from parents to children. Low basis property owners with generational wealth need to be aware of this tax bill rule change which goes into effect on February 16, 2021. If you have a low basis property that you would like to keep in the family, you may want to consider gifting it now.

The Parent-Child Property Tax Exclusion

As a property owner, were you thinking of gifting or leaving an appreciated piece of property to your children during life or as part of your estate plan that they would continue to enjoy for years to come?  Under current law, you can transfer a primary residence (of any value) during lifetime or at death to your kids and it will NOT trigger a property tax reassessment.

The kids do not need to reside in the home. They could even convert the home into a rental property.  Not only that, but you can transfer up to $1 million of “non-principal residence” property (e.g., a rental property, vacation home or commercial property) per person, to your kids over your lifetime. So, a couple can currently exclude up to $2 million in assessed property value (often much lower than current fair market value) from future property tax reassessment.

As of February 16, 2021, the specific Proposition 58 guidelines above will change and be replaced by Prop 19.  Any primary residence transfer will require the children to use the gifted property as their own principal residence in perpetuity or it will be reassessed for property tax purposes.

There will also be a cap introduced on the assessed property value exclusion above of $1 million, even if the child uses the property as their primary residence. Finally, the “non-principal residence” transfer exclusion will be eliminated for all rental, vacation, commercial properties, etc.

Examples:

1. Primary residence:  As older homeowners, assume your home is worth $3M and you purchased it 30 years ago. Its current assessed property tax value is $500K. Under current rules, you can transfer your residence to your children during life or at death and the kids can inherit your (much lower) assessed property tax value, whether they plan to live there or not. They may decide to rent out the inherited property in the future. There is no limitation to the value of the home in this transfer.

Under the new Proposition 19 rules effective February 16, 2021, if you transfer your residence to the children, one of them must live there immediately after the transfer of property, or else a property tax reassessment will be triggered. There is also a new $1M limitation on the current taxable value exclusion. In the example above, this means of the $2.5M increase in taxable value, anything above the first $1M is added to the current tax assessed value. So, the new reassessed value for the children upon transfer would be $2M and therefore subject to a large property tax increase (i.e. $500K current taxable value + $1.5M increase in taxable value above the $1M exclusion = $2M in reassessed value).

2. Multifamily rental property:  Let’s assume you and your spouse own a multifamily rental property in town worth $4M that you purchased years ago. Its currently assessed property tax value is $2M. Under current rules, you can transfer this rental property to your children, and they can inherit the $2M assessed property tax value because, as a couple, you can exclude up to $2M of assessed property value from property tax reassessment during your lifetime.

Under the new California Proposition 19 rules effective February 16, 2021, the “non-principal residence” property (e.g., rental property, vacation home, or commercial property) exclusion is eliminated, and no property tax benefit will result from intrafamily rental property transfers.

 

This law change may also spoil estate planning techniques like the Qualified Personal Residence Trust (QPRT), whereby a residence can be transferred from parent to child (and parent continues to live in the home for a fixed number of years) to shift future appreciation out of the parent’s estate. This wealth shifting technique will be impacted by Prop 19 as the residence would then need to be occupied by the children as their primary residence. This could impact QPRT’s with terms ending after February 16, 2021, via property tax reassessments.

There are various client specific considerations to be addressed when planning for an asset transfer event, such as:

  • Was the property originally purchased in a legal entity or is it held in trust?
  • Can the family afford to gift property to the children and lose future income streams and/or the potential for a step up in basis at the parent’s death?
  • Does the fair market value of the property significantly exceed the assessed value and income tax basis?
  • Will the children retain the property for decades if it is transferred now to compound the benefits of a much lower annually assessed property tax value?
  • Have the parents already gifted a portion of their lifetime estate tax exemption amount?
  • May the parents be subject to estate taxation someday based upon current (or potential future) estate tax exemption amounts?

Bottom Line

If you are a California homeowner and have a low basis property you would like to keep in the family, explore the possibility of gifting it now. Each client situation is unique, so it is best to talk through your specific scenario with one of our  financial advisors at Dowling & Yahnke Wealth Advisors as well as your tax accountant and estate planning attorney.

 

Please note that this material is presented for informational purposes only and should not be construed as individual legal, tax, or financial advice.  When considering estate planning strategies, the individual should always consult with the individual’s own legal, tax, and financial advisors.

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