On November 3, 2020, California voters approved Proposition 19 which brings substantial changes to California’s property tax assessment rules and will greatly impact property tax planning for parents and children. Property owners wishing to avoid Proposition 19 must make transfers by February 15, 2021.
A. Current law under Propositions 13 and 58 – effective through Feb. 15, 2021
Under current California law, properties are taxed for property tax purposes based on their assessed value (also referred to as the “base value” or “taxable value”) rather than the property’s fair market value. In general, the assessed value is the purchase price of the property plus cost of improvements, plus an increase of not more than 2% each year. This general rule applies until there is a change of ownership which triggers reassessment of the property.
Under the current property tax rules, a parent can transfer ownership of his or her principal residence to one or more children without causing the property’s value to be reassessed. The transfer is commonly referred to as the “parent-to-child exclusion.” This parent-to-child exclusion from reassessment is available regardless of: (a) the value of the principal residence; and (b) of how the child or children use the residence (e.g., vacation home, rental property, etc.). The parent-to-child exclusion is also available for up to $1,000,000 of the assessed value of other real property (e.g., second homes and investment properties). The $1,000,000 exclusion is available for each parent, allowing parents together to transfer property with $2,000,000 of assessed value.
B. Changes brought under Proposition 19 – effective after Feb. 15, 2021
1. Principal residence requirements and adjustments to assessed value
Proposition 19 requires that the child or children use the residence as their own principal residence. If the residence is not used as the children’s principal residence, the property will be reassessed at its fair market value. If one child will use the property as his or her residence but the other child will not, then one-half of the residence will be reassessed subject to the other provisions described below.
Additionally, Proposition 19 imposes other limitations that may result in increased assessment. Specifically, under the new rules there will be a $1,000,000 cap on the available exclusion. If the increase in value from the current assessed value of the property will be less than or equal to $1,000,000, there is no adjustment made. If the increase in value is greater than $1,000,000, the increase in value in excess of $1,000,000 will be reassessed.
Example – Mom purchased a home which has a current assessed value of $1,000,000, with a current value of $2,000,000, so the home has an increased in value of $1,000,000. If mom transfers the home to a child after Feb 15, 2021, the new reassessed value will be $1,000,000 (the fair market value of $2,000,000 less $1,000,000). If Mom transfers this home to her children by February 15, 2021, her children maintain the current assessed value of $1,000,000, regardless of the current fair market value of the home on date of transfer and regardless of whether it is treated as the children’s personal residence.
2. $1 million lifetime non-principal residence exclusion eliminated
Proposition 19 will also completely eliminate the ability to transfer $1,000,000 (or $2,000,000 for a married couple) of assessed value of property besides the principal residence. This includes vacation homes, rental properties, business properties, etc.
Example – Parents want to transfer their primary residence home and a rental property to their son. The home has an assessed value of $500,000 and a fair market value of $2,000,000. The rental property has an assessed value of $300,000 and a fair market value of $3,000,000. On any transfers after February 15, 2021, there will be a full reassessment on the transfer of the rental property to son. The new assessed value of the rental property will be its fair market value ($3,000,000) because there is no exemption from reassessment available for transfers of real property from parent to child other than the primary residence. Additionally, as outlined above, if the home is transferred after February 15, 2021, there will be an adjustment to the assessed value of the home because the fair market value exceeds the assessed value by more than $1,000,000, and the son must also use the home as his primary residence to even receive the $1,000,000 exclusion from reassessment.
In addition, while these changes to the parent-to-child exclusion under Proposition 19 will certainly impact many prospective estate planning decisions, they can also impact estate planning trusts established years ago as well, including any qualified personal residence trusts (“QPRT”). Estate planning strategies already in place such as the QPRT, if not terminated by February 15, 2021, will be reassessed under the rules described above.
Hence, it is wise to discuss the above issues with your legal counsel.
C. The Silver Lining – Other changes affecting transfers of taxable values and Proposition 19‘s effect on property held in legal entities
There is a beneficial change which impacts transfers of taxable value from a homeowner’s current home to a new property. The current property tax rules permit homeowners who are over the age of 55, or certain disabled persons, to transfer the taxable value of their current home to a new property so long as the new home is in the same county as their current home, the value of their new home is less than or equal to the value of their current home and the county permits this exclusion, which many counties currently do not.
Under Proposition 19, victims of wildfires or other natural disasters, regardless of age or disability status, will also be eligible to transfer their taxable value. Also, all counties must conform to these rules. Further, the new home is not required to be in the same county as the old home as the new home can be located anywhere in California. Finally, the new law permits homeowners to buy a replacement home that is worth more than their old home, but any increase in value must be added to the assessed value of the old home.
The changes to the parent-to-child exclusion rules are not applicable and have not changed the rules regarding properties held in legal entities such as corporations, partnerships, limited liability companies, etc. A different set of rules are used to determine when there has been a change in ownership triggering property tax reassessment for properties held in legal entities and these remain in place under the new law.
Proposition 19 is set to take effect February 16, 2021, and any transfer made on or after February 15, 2021 will be subject to the new rules. As such, any property owners who are looking to avoid Proposition 19 should contact legal counsel as soon as possible to assist in determining if any real property transfers should be made by February 15, 2021.