Proposition 19 was passed in November 2020 by California voters. This proposition was marketed to voters as a way to protect the property tax basis of a primary residence for seniors 55+, those who are severely disabled, and victims of wildfire and natural disasters, but what they didn’t tell you was that it also essentially eliminated the parent/child exclusion which protected families from high property tax reassessments. This law will go into effect on February 16, 2021.
Under the current law, a parent can transfer any property they own in California to their child, and the child will receive the benefit of the parent’s low property tax value since the parent to child transfer is excluded from property tax reassessment. This means if a parent bought a property in the 1970s and has a tax basis that is extremely low, the child will be able to assume those low property tax payments when they take title to the property. This also applies in the same way for grandparent to grandchild transfers, however for the grandparent/grandchild exemption, both parents of the child are required to be deceased to qualify. (Note: I should point out that parents who do these transfers to their kids for no consideration (zero dollars) will likely incur a gift tax depending on the value of the transfer).
Under the new law, a parent may only transfer their primary residence (meaning they filed a homestead exemption for the residence) to their child at a value of up to $1 million, and the child must live in the property as their primary residence for the transfer to be excluded from property tax reassessment. The child must move into that property within 1 year of the date of transfer and must claim a homeowners’ exemption. Any transfer between parents and children that are not the primary residence (ie/ investment, vacation or rental properties), or transfers where the child does not intend to live in the property as a primary residence, the property will be reassessed at current fair market value as of the date the deed is recorded. This will result in significant increases in property tax payments for intra-family transfers of real property going forward. It also means that if a child inherits a property from their parent’s trust on the death of the parent, and property was not the decedent parent’s primary residence, the property tax will be reassessed as of date of death.
Keep in mind that even partial transfers could trigger a reassessment. If a parent transfers 50% to their child so they are 50-50 owners on title, and the property is not a primary residence of either the parent or the child, the property will be reassessed 50% at fair market value.
After April 1, 2021 under Prop 19, Seniors 55+ and severely disabled persons have the ability to purchase a new principal residence anywhere in California (up to 3 times), and transfer their lower property tax basis from their existing property to their new property. The new property must be of equal or lesser value to the property being sold to avoid any partial property taxes owed. There is a similar provision for victims of wildfire and natural disasters.
The question becomes whether for planning purposes, a parent should transfer their properties to their children now before February 16, 2021, or whether they should leave those properties in their trust so the children can inherit them. The downside to transferring the property now is (1) the gift taxes incurred by the parent, and (2) the child steps into the parent’s shoes and takes the property at the value the parent first purchased it at (ie/ in 1970). This means that if the child goes to sell the property that was gifted to them now, they would incur capital gains taxes on the increase in value from when the parent purchased it to when the child sells it. Capital gains taxes could be as high as 20%, so this is not insignificant. The downside to not transferring it now, and letting the child inherit the property on the parent’s death is that the property taxes will be reassessed as of date of death. However, the major benefit to this option is that the child would inherit the property at fair market value as of date of death (also known as a “step up in basis”) meaning that if the child sold the property after the date of death, the capital gains would be extremely low, if any at all. Also, the estate tax for 2021 is capped at $11.7 million, so there is a strong possibility no estate taxes will be due (unless the estate tax cap is changed). There is a chance depending on the election outcome that the step up in basis could be eliminated in the next few years, and if that is the case, the children would get hit with both a property tax reassessment and the very high capital gains, but this is an unknown at this point. It is advisable that property owners considering one of these options speak to their CPA, tax attorney or accountant to crunch the numbers to see which option makes the most financial sense. They should also contact a real estate attorney like myself to discuss the property transfer options. Either way, the unfortunate outcome is that the State of California will get its money if you own property here.
The BOE prepared a simple chart showing the differences between current law and the new law going into effect under Prop 19 if you click here.
I am a real estate attorney and not a tax attorney or CPA, so this blog is not intended to construe any tax advice or legal advice, and is specific to the laws of the State of California. If you have questions about this article, please contact attorney Ashley Peterson.