2020 Tax Planning: Preserve Low Property Taxes for Next Generation before Prop 19 Takes Effect

By Kit Driscoll.

Please note: If you have questions regarding Proposition 19 or would like to discuss potential gift and/or sale strategies related to the legislation, we ask that you first please fill out our Prop 19 Inquiry Form here so we can determine whether we are best suited to respond to your specific inquiry and/or represent you in your matter during this time.

California’s unofficial election results[1] indicate that Proposition 19, one of the two Propositions affecting California property tax rules, passed and will affect transfers after February 15, 2021.  Commercial and industrial property owners need not be concerned about the split roll that would have assessed property taxes based on fair market value as Proposition 15 did not pass.  Real property owners should consider strategies to preserve low assessed values of legacy properties before Proposition 19 takes effect.

Proposition 19 dramatically changes the property tax rules exempting the following:

  • Primary residence transactions for certain individuals such as those over age 55, severely disabled, or victims of wildfires or other natural disasters. The new rules for this category are generally favorable and may result in tax savings for a qualifying homeowner by allowing the assessed value of their principal residence to be transferred to a replacement residence in any California county. Unlike current law, the new rules may provide a significant benefit even if the replacement residence is more expensive than the principal residence that is transferred.
  • Certain intra-family transfers. The new rules for parent-child and certain other intra-family transfers significantly increase the cost to future generations of keeping legacy properties within the family, as illustrated below.[2]

Current Property Tax Rules and Exemptions

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. Because average appreciation of California real property has far exceeded the 2% annual adjustment since the enactment of Proposition 13 in 1978, long time owners of California real estate generally enjoy a very low property tax burden relative to owners of newly acquired property.

California currently provides two valuable exemptions from reassessment, which allow the continuation of this benefit after transfers of qualifying property interests between parents and children.[3] First, a transfer of parent’s principal residence to a child is completely exempted from reassessment. The child succeeds to the parent’s assessed value regardless of the value of the property or its assessed value at the time of transfer. Second, transfers of real property interests which are not the parent’s primary residence (residential or commercial) are exempted from reassessment to the extent of $1 million of assessed value, regardless of the fair market value of the property.

New Property Tax Exemptions Under Proposition 19

Proposition 19 revises the Parent-to-Child exemptions to limit (1) the types of transfers between parents and children that can be exempted from reassessment, and (2) the property tax benefit available. First, only a transfer of the parent’s principal residence to the child where the property continues as the child’s principal residence qualifies. Second, provided the transfer meets the principal residence requirements, the child’s 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 $1 million or more, then the child’s assessed value is the current value of the property less $1 million.

Illustration of Proposition 19

The following hypotheticals illustrate the consequences under current law versus Proposition 19.

Hypothetical No. 1 – Prop 19 Increases Taxes 10x

Facts:

  • Property #1 is Mom’s principal residence: $10M FMV, $500,000 assessed value
  • Property #2 is Mom’s secondary residence: $5M FMV, $1M assessed value
  • Mom’s total assessed values that she pays property tax on is $1.5M
  • Property tax rate is 1.25% (estimated)
  • Mom’s estimated total property taxes are $18,750
  • Mom gives Property #1 and Property #2 to Child and claims exemption
  • Child does not use either property as principal residence

Child’s Assessed Values and Property Tax Consequences:

Current Law Proposition 19
Property #1 assessed value $500,000 (exempt under R&T Code Section 63.1(a)(1)(A))

Property #2 assessed value $1M (exempt under R&T Code Section 63.1(a)(1)(B))

Properties #1 and #2 are both reassessed to their fair market value because of the requirement the property be both Mom and Child’s principal residence before and after transfer, respectively
Assessed value is $1.5M, total, same as Mom’s Assessed value is $15M, total
Property tax is $18,750, total, same as Mom’s Property tax is $187,500, total

 

Hypothetical No. 2 – Prop 19 Increases Taxes 9.3x

Facts:

  • Same facts as Hypothetical No. 1, except that Child maintains Property #1 as Child’s principal residence after the transfer.

Child’s Assessed Values and Property Tax Consequences:

Current Law  Proposition 19
Same result as Hypothetical No. 1

Property #1 assessed value $500,000 (exempt under R&T Code Section 63.1(a)(1)(A))

Property #2 assessed value $1M (exempt under R&T Code Section 63.1(a)(1)(B))

Property #1 receives a limited exemption from reassessment of the fair market value, less $1M ($10M – $1M = $9M)[4]

Property #2 is reassessed to its fair market value because of the requirement the property be both Mom and Child’s principal residence

Assessed value is $1.5M, total, same as Mom’s Assessed value is $14M, total
Property tax is $18,750, total, same as Mom’s Property tax is $175,000, total

 

Please fill out our Prop 19 Inquiry Form here if you would like to discuss Proposition 19 and potential gift and/or sale strategies that are available under current law and will not be available to any transfer after February 15, 2021.

 

[1]  See the “Unofficial Election Results” on the California Secretary of State’s website.

[2]  R & T Code Section 63.1 provides the “Parent-to-Child” exemptions. The Parent-to-Child exemptions are for transfers “between” parents and children. The Parent-to-Child exemptions are also available for transfers between grandparents and grandchildren in certain circumstances. For purposes of this illustration, “parent” is the transferor and “child” is the transferee.

[3]  Note that certain procedural requirements must be satisfied to benefit from these exemptions and that other types of exemptions exist other than the Parent-to-Child transfers.

[4]  If Property #1 FMV were instead $1M, then the assessed value would remain $500,000 and Child would have same property tax as Mom for Property #1