Businessperson's Hand Protecting Balance

Our take on

PROPOSITION 19

Drastic Changes to the Property Tax Laws

for Parent-Child Transfers

(Get Out Your Crystal Ball)

 

by Darcey L. Wong and Briannon J.C. Siv

UPDATE: We are not taking on any Prop 19 Planning, but read on to get educated or to request a referral, IF needed.

 

Proposition 19 drastically changed property tax law for real property transfers from parents to children in California. My inbox has been inundated with inquiries as I have been writing this article from my home office. 

 

Here is the bottom line: Proposition 19 eliminated the parent-child (and grandparent-grandchild) exclusion from property tax reassessment in most cases. This means that in the future, your children are likely going to be paying more property tax than you are now for a property they keep after inheriting it, receiving it as a gift, or purchasing it from you. This new law goes into effect on February 16, 2021. The change in the law effects residential and non-residential properties owned by parents who plan on transferring those properties to their children at some point (usually upon their death as an inheritance), and there are a variety of actions that can be taken now to avoid an increase in property tax later, but those actions may not be right for your specific situation. The proposition is so new and different that the Board of Equalization is still drafting guidance to the County Assessors about how to implement the new law. So should YOU take any action now? Unfortunately, it really depends on your very specific situation and gauging future events with your crystal ball.

 

This article is intended to present information about Proposition 19 to bring general awareness to how you may be affected and help you critically think about whether you would like to look further into this law as it applies to you. It should not be relied upon as legal advice specific to your situation, nor should it be fully relied upon for complete accuracy, as this is a new law that is still being interpreted and implemented and there may be unanticipated developments, legal interpretations, or legal challenges to this law.   

 

Part 1 of this article explains how Proposition 19 works as it relates to the reassessment of property taxes between parents and children for estate planning purposes. 

 

Part 2 of this article lists general considerations to evaluate yourself as a “good” (or “bad”) candidate for Prop 19 planning.

Part 3 of this article lists some other helpful resources and will be updated from time to time, so please feel free to check back here anytime.


PART 1
PROPERTY TAX LAWS

 

Prop 19 and Primary Residences

 

Today, under Proposition 58, you (as a parent) can transfer your primary residence to your children by gift, sale, or inheritance, and your children would have the same property tax bill as you, regardless of how your children actually use the property—as a residence, vacation home, or rental. This is because your children get to keep your taxable value for property tax purposes. If you purchased your property, your "taxable value" is based on the amount you originally paid for the property, plus some adjustments (remodeling/additions), along with annual increases based on inflation capped at 2%. You can find that figure on your property tax bill often labeled "Taxable Value" and is the sum of your Land and Improvements/Structure, etc. values.  After subtracting any homeowner's exemption you get a net taxable value. This also applies to grandparent-grandchild transfers, but only if the parent of the grandchild is predeceased.

 

Now under Proposition 19, when you transfer your “family home” (or "family farm") to a child, the property will be reassessed if the child does not use it as his or her own primary residence. If your child does make it his or her primary residence, if the fair market value at that time is less than the sum of the taxable value plus $1 million, then the taxable value does not change. But, if the fair market value is more than the sum of the taxable value plus $1 million, your taxable value (and property taxes) will increase by that difference. Property taxes are about 1.2% of the taxable value plus other local special taxes and assessments. See below for a simple calculation.

 

Prop 19 and Other Real Property

 

Today, you (as a parent), can transfer all your other property (non-primary residence) to your children and your children would have the same property tax bill as you, with a limit of $1 million of aggregate taxable value for all such properties per parent, for a total of $2 million for two parents.

 

Now under Prop 19, the parent-child (and grandparent-grandchild) exclusion has been eliminated entirely for non-primary residential property. This includes vacation homes, rentals, commercial properties, and raw land. All of this type of real property (other than the family farm containing a residential property) will be reassessed to fair market value upon any transfer (gift, sale, inheritance) and the amount of property taxes will reflect this increase. Thus, your children’s property tax bill for all non-primary residential real property will increase when you pass away (assuming it has appreciated above the taxable value).

What does this mean to you?

 

Transfers of property made before February 16, 2021, will be governed by the current exclusions from reassessment (under Prop 58). That leaves a small window of opportunity to take some sort of action to preserve the taxable value of your properties and avoid an increase in property taxes for your children. However, this change in the law may not matter to you or it might not make financial sense to take any action. In order to figure this all out, you will need to do a thorough analysis of your situation before taking any action.

 

The simplest action that can be taken is to make a gift of your debt-free non-residential property to your children before February 16, 2021. However, your children will lose the step-up in income tax basis received if they were to inherit the property instead. The property tax savings could easily be dwarfed by a large income tax bill due upon a subsequent sale of the property. If you make a gift, because you will no longer be the owner, you will not receive any income or deductions from the property anymore. If you gift a residence, you will need to pay market rent to your children in order to continue to live in the house.

 

There are more complex actions that can be taken involving newly-devised irrevocable trusts that some estate planners are implementing as a possible solution to keep the property tax the same for your children and get a step-up in income tax basis upon your death. These trusts are not simple and results are not guaranteed.

Calculating the Effect of Prop 19 - A Simple Example

EXAMPLE
OF A
SIMPLE
OUTRIGHT GIFT
FROM A PARENT
TO A CHILD

Assumptions

 

 

 

 

 

 

 

 

 

Property Tax Rate: 1.2% plus $1,700 charges

Long-term capital gains
income tax rate (combined federal and CA): 35%

Current exemption from gift/estate tax:

$11.7 million per

donor/decedent

(set to decrease by half in 2026)

Current annual gift tax exclusion: $15,000/donee

Facts of the
Situation

 

Real Property

Taxable Value: $100,000

Property Tax: $2,900/yr

 

Cost Basis: $100,000

 

Market Value / Sales Price if Sold: $1,500,000

Built-in Capital Gains: $1,400,000

Gift/Estate tax value if gifted: $1,500,000

If Gifted Now
to Child
under
current law
(before Feb 16)

 

 

 

 

Taxable Value: $100,000

Property Tax: $2,900/yr

(stays the same as yours)

Cost Basis: $100,000

(stays the same as yours)

 

IF sold after gifted: $1,400,000 capital gains or $490,000 tax due (BIG tax bill) ($250,000-$500,000 capital gains exemption for a primary residence may be available)

IF not sold after gifted, and the child passes property down to his or her child at death, Prop 19 applies and basis is stepped-up (if laws do not change.)

If No Action and Inherited by Child
under Prop 19

 

 

NON-PRIMARY RESIDENCE:

New Taxable Value = Assessed Value: $1,500,000

Property Tax: $19,700/yr

(BIG property tax bill)

Cost Basis: $1,500,000

(step-up in basis)

IF sold: $0 capital gains or

$0 tax due

PRIMARY RESIDENCE

(OF YOURS AND CHILD'S):

New Taxable Value: $500,000

(Old $100,000 + Additional $400,000 = $500,000)

Property Tax: $7,700/yr

Cost Basis: $1,500,000

IF sold: same as above

(no capital gains tax)

PART 2
SHOULD YOU PLAN NOW? SELF-EVALUATION

 

Are you a good candidate for Proposition 19 Planning?

 

We understand the “it depends on your situation” answer, however true, is not very helpful. Due to capacity and timing, our firm is not taking on new inquiries to analyze your situation and answer this question. So we have laid out some general considerations to help address your concerns. We have listed some possible typical characteristics for someone who is: (1) not a good candidate for Prop 19 planning; (2) is a good candidate for an outright gift transfer now; and (3) is a good candidate for more complex Prop 19 planning now.

 

Here are some characteristics that might indicate that you are

NOT A GOOD CANDIDATE FOR PROPOSITION 19 PLANNING*:

 

  1. You believe that your child may likely sell the property once inherited, whether immediately or within a few years

  2. You have a “high” taxable value for property taxes that is equal or near fair market value (for example, because it was recently purchased, reassessed, or remodeled)

  3. You wish to leave it up to your children to decide what to do with inherited real property when the time comes, including handling any costs (such as property taxes) of keeping the property

  4. You have more than one child and they will need to share ownership of the inherited property, so will likely sell the property rather than be co-owners

  5. You are not willing to gift your property to your children (either outright or in trust)

  6. You are not willing to transfer your primary residence to you children and pay them market rent

  7. You are not willing to give up any ownership or control of the property

  8. You cannot afford to give up any income and deductions from the property

  9. Your property has a mortgage or other debt against it

  10. Your property has a low cost basis

  11. You want the step-up in cost basis after the first spouse dies

  12. You want your children to get a step-up in basis after you or the surviving spouse dies

  13. Your child plans on making the property his or her primary residence, and the difference between the taxable value and market value is not well over $1 million

  14. Your children will not be able to deal with complex estate planning strategies after you pass away

  15. You have already used up your current exclusions under Prop 58 (used up $1 million exclusion for properties other than primary residence)

  16. You do not like complexity

  17. You do not like uncertainty

  18. You think the property tax law might change again before you pass away

  19. You do not wish to implement an untested strategy to save taxes

  20. You do not want to spend a lot of money to plan now

  21. You do not have time to deal with this project in the coming weeks

  22. You like to take your time when making major decisions and you feel too rushed at this time

 

*Please note, no one factor or even all factors are a true indication of whether you are or could be a good candidate to engage in Proposition 19 planning. This list is intended to help you think critically about whether pursuing these planning options may be a right fit for you, as there are certainly trade-offs to consider when contemplating such planning.   

 

 

Here are some characteristics that might indicate that you and your property are a 

GOOD CANDIDATE FOR AN OUTRIGHT GIFT TRANSFER:

 

  1. You have a “low” taxable value for property taxes (as compared to market value)

  2. You are really concerned about your children being able to afford paying more property taxes on an inherited property and the children need to keep the property as a rental or vacation home (and not sell it)

  3. You are really concerned about your children paying more property taxes on an inherited property because they will be using it as their primary residence and even a partial reassessment would be more than they could afford to stay in the family home

  4. Your children would not be willing to buy a replacement property with the sales proceeds from selling the inherited property even though there could be no capital gains

  5. You are willing to give up full ownership and control of the property now

  6. You are willing and can afford to give up any income and deductions from the property

  7. You are willing to gift your property outright to your children (not in trust)

  8. Your children are adults capable of managing the property now

  9. Your property has no mortgage or other debt against it

  10. Your property has a “high” cost basis (near or equivalent to market value) because you received a step-up in cost basis from inheriting the property in recent years (including from a spouse that has passed away recently)

  11. Your property has a low basis, but your children will not sell the property during their lifetime (or will not sell for many decades after your death to reap the benefits of the property tax savings)

  12. Your child does not plan on making the property his or her primary residence

  13. You have not used up your current exclusions under Prop 58 (has not used up $1 million exclusion for properties other than primary residence)

  14. You have no lawsuits pending against you or the property

  15. You are willing to complete an appraisal, one or more gift tax returns, and expend the time and money now on a thorough analysis of your situation, as well as the legal fees associated with this gift planning

 

 

Here are some characteristics that might indicate that you and your property are a

GOOD CANDIDATE FOR MORE COMPLEX PROPOSITION 19 PLANNING:

 

  1. You have a “low” taxable value for property taxes (as compared to market value)

  2. You are really concerned about your children paying more property taxes on an inherited property because they need to keep the property and have low property taxes

  3. You are not willing to transfer full control of your property to your children now

  4. You are not willing to give up all the cash flow or pay market rent to your children, but are willing to deal with the expense and complexity of an installment sale to your children

  5. You are not willing to gift your property outright to your children, but are willing to deal with the expense and complexity of setting up irrevocable trusts

  6. Your property has no mortgage or other debt against it

  7. Your child does not plan on making the property his or her primary residence

  8. Your child does plan on making the property his or her primary residence, but the difference between the taxable value and market value is well over $1 million

  9. You have not used up your current Prop 58 aggregate $1 million exclusion for properties other than primary residence

  10. You have no lawsuits pending against you or the property

  11. You are available to meet with attorneys who are taking on this type of planning in order to get started immediately

  12. You are willing to complete an appraisal, one or more gift tax returns, and expend the time and money now on a very thorough analysis of your situation, as well as the legal fees associated with complex planning.

 

 

PART 3

OTHER RESOURCES

Law Offices of Darcey L. Wong, P.C.

1900 S. Norfolk Street, Suite 350, San Mateo, CA 94403

Email: dwong@sfestatelawyer.com
Tel:  650-578-0300

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