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December 2020: The following has been updated to reflect the passing of Proposition 19
California Proposition 19 barely passed last month with a 51% vs. 49% vote. It seemed there were some misunderstandings about the details, therefore the Board of Equalization has since provided further clarification. With that clarification, a couple of time-sensitive considerations arise for families planning to pass down properties to their heirs.
Proposition 19 states that for primary residences, the heir that inherits the property and treats it as his or her primary residence may keep the parent’s assessed value for determining property taxes provided the fair market value of the property is not more than $1 million higher than the assessed value. For a property whose fair market value exceeds the assessed value by greater than $1 million, the heir is entitled to a new assessed value equal to fair market value minus $1 million.
An example to illustrate Proposition 19:
Joe inherits a property after the passing of his mother. This property has a fair market value of $3 million and an assessed value of $600,000. Since the fair market value of the property exceeds the assessed value by more than $1 million, Joe will not be able to retain his mother’s assessed value. Rather, Joe’s adjusted assessed value will be $2 million if he moves into the property within a year after her passing and maintains it as his primary residence.
Proposition 19 also states that properties other than primary residences will not get ANY exemptions and will get reassessed after owners pass away. If in the above example Joe keeps the property but does not use it as his primary residence, the assessed value will be $3 million.
Many have noted that the language around this proposition was unclear, and it is likely that many voters did not understand what they were voting for or against, but the net effect is a large tax increase to families with sizeable real estate holdings as these assets are passed down to children. This was precisely the intent of the new law: To provide older Californians with some greater flexibility to choose between remaining in their highly-appreciated home or moving within the state, while limiting the ability for Californians to pass on real property without an increase in assessed value for property tax purposes.
Now, with its passing, there’s a significant urgency to plan for our California real estate assets before the new law takes effect on February 16, 2021. There are a few strategies one might execute prior to that date.
1) Gifting a property to retain the tax base
Property owners may deed/gift their property to an heir directly before February 15, 2021. Under this strategy, the parents may reside in their home and the heir will be able to keep the property tax base and its lower property tax bill for as long as he or she keeps the property. There is a price to pursue this strategy, however, that would need to be considered: The heir will also inherit the parent/grandparent’s “tax basis” when calculating capital gains upon sale. So, when the heir decides to sell the property, he or she will have to realize all capital gains from his or her parent’s tax basis. While tradeoffs exist, a gift of property prior to the February 16th deadline may be useful if the property is not a principal residence, or if the fair market value exceeds the assessed value by more than $1 million. There may also be gift tax implications at the time of the giver’s death, depending upon the size of their estate, and the amount of the estate tax exclusion at time of death.
2) Setting up an incomplete gift trust to hold the property
Parents may create an irrevocable trust for the benefit of their heirs, contribute the property to it prior to February 16th and build provisions into the trust that preserve control over key elements of the trust for the parents, rendering this gift “incomplete.” Properly following this approach appears to have two benefits. First, the property would maintain its assessed value under the current law; and second, the property should remain in the parent’s estate, enabling the children to benefit from a step-up in tax basis (for the purpose of determining capital gain upon the property’s eventual sale, not property taxes) at the time of the parents’ death.
3) Creation of an LLC to hold the property
Parents may gift a majority interest in a property to their children prior to February 16th to take advantage of the parent-to-child exclusion that exists under current law. The collective owners can transfer these interests in the property into an LLC, which will provide liability protection and other benefits to family members over time while preserving the assessed value for computing property taxes. Upon the death of the parents, there will still be no increase in assessed value under Prop 19 since less than a majority interest in the property transfers to heirs at that time.
PLEASE NOTE: The above is not to be construed as advice but rather as a summary of the effects of Proposition 19 as we understand them. Each family situation involves different goals and considerations, and any strategy discussed may or may not have applicability. The strategies suggested above are complex and should only be carried out under the advice of a qualified attorney. Please consult your advisor and estate planning attorney to discuss your specific situation.
Original post by John Wei, CFP®CPWA® – October 2020
If the new California Proposition 19 passes during November 2020, it could spell property tax implications for Bay Area residents thinking of making a move, and even more so for those inheriting property.
There are several key propositions already in place that afford Bay Area homeowners opportunities to retain or transfer a low property tax basis, making it more affordable and even lucrative to remain in California for the long term. For those wishing to remain in California, but perhaps considering a move to a smaller home, Propositions 60 & 90 (passed in 1986 and 1988, respectively) are important constitutional tax initiatives to understand. If an inherited property may be in your future, or you’re working through your estate planning, Proposition 19, as well as the existing Proposition 13 (1988), are ones to brush up on.
California Proposition 19 is positioned as a “tax relief” as it broadens the accessibility and benefits of previous propositions 13, 58, 60 & 90 to “seniors, wildfire victims, and people with disabilities.”
Under the existing Proposition 13, property taxation for homes that have not sold or undergone new construction is based on the property value as of the later of 1975 or the purchase date, with annual increases limited to an inflation rate not to exceed two percent of California CPI, whichever is less.
Currently, eligible California homeowners can transfer their tax assessments to a different home of the same or lesser market value if the new home is located within certain counties. This allows seniors 55 and over to downsize, and/or move closer to family members without suffering a property tax hike.
Proposition 19 allows transfers anywhere in the state and allows the new property to be of greater value. The Caveat: these higher-valued homes will have an upward adjustment to the property tax basis. For example, if a senior couple were to sell their home with an assessed value of $450,000 for $3,000,000, and acquire another home for $4,000,000, the new home’s assessed value would be $1,450,000 ($450,000 plus the increase of $1,000,000 in home value).
To understand the implications of a yes vote on 19, let’s first review the propositions already in place.
In California, based on Proposition 58 (an addition to Prop 13 passed by voters in 1986), parents or grandparents can transfer primary residential properties to their children or grandchildren, of an unlimited amount, without the property’s tax assessment resetting to market value. Homes or business properties that are not considered primary residence can also be transferred from parent/grandparent to child/grandchild with the first $1,000,000 exempt from re-assessment when transferred.
For example, if Joe inherits a home from his parents with an assessed value of $700,000, under Proposition 58, Joe also inherits the low property tax bill of about $8,000 per year, even if the house has a fair market value far greater than the assessed value.
Proposition 19 would eliminate the exemption if the child does not live in the transferred property as his primary residence within the first year of inheriting the property. In this case, if Joe inherited the family home and simply cannot make the home his primary residence, perhaps sharing the inheritance with siblings, the $8,000 annual bill on a property with a current market value of $2,500,000 million will become roughly $28,000.
However, the proposition also would trigger an upward tax assessment for owner-occupied inherited properties after February 16, 2023, for properties with a market value more than $1,000,000 greater than taxable value.
Proposition 19 was proposed in some part to address issues with the thousands of people who’ve lost their homes in the wildfires this year and to bring in more tax revenue to fund schools that lack funding.
Here’s what could change (or not change) with Proposition 19:
|Yes on Proposition 19||No on Proposition 19|
|Will allow eligible homeowners to transfer their tax assessments anywhere within the state and allow tax assessments to be transferred to a more expensive home with an upward adjustment||Based on existing Proposition 60 & 90, eligible homeowners can transfer their tax assessments within certain counties and to homes of equal or lesser market value|
|Increases the number of times that persons over 55 years old or with severe disabilities can transfer their tax assessments from one to three (disaster victims are allowed one transfer)||Keeps the number of times that persons over 55 years old or with severe disabilities can transfer their tax assessments at one|
|Requires that inherited homes that are not used as principal residences, such as vacation homes, businesses, or rentals, be reassessed at market value when transferred||Allows inherited homes not used as principal residences, such as vacation homes, businesses, and rentals to be transferred from parent to child or grandparent to grandchild without impact for those properties with a market value assessment under $1,000,000|
|Allocates additional revenue or net savings resulting from the ballot measure to wildfire agencies and counties.|
Planning a move is a big decision. In fact, there are no small decisions when it comes to real estate in the Bay Area. Your personal circumstances must be carefully considered. Having an advisor who can walk through the scenarios and tax implications, among other financial considerations, can provide clarity and peace of mind.
If you’re still unsure about how Proposition 19 or the others referenced could affect your plans, consult with your Summitry Financial Advisor. If you aren’t yet a Summitry client, contact us today.
Interested in more election-based perspectives? Read “How the Election Affects the Stock Market?” and our key takeaways from a recent Election 2020 Outlook webinar featuring Dan Clifton, Strategas Partners.
All material of opinion reflects the judgment of Adviser at this time and are subject to change. This material is not intended as an offer or solicitation to buy, hold, or sell any financial instrument or investment advisory services.
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