California is about to go through a dramatic change to real estate and property tax assessments with Proposition 19 (Prop 19) going into effect on February 16, 2021. Prop 19 replaces Proposition 58 (Prop 58), which has provided a favorable transfer of real estate from parent to child. It is important to understand these changes to see if you need to make any immediate changes to your real estate holdings before Prop 19 takes effect.
How do current laws work?
Currently, real estate with a low tax basis can be transferred during the parent’s lifetime or at death to a child and the child keeps the low basis and it does not trigger a tax reassessment. This rule applies to both primary residences and rental properties. The kids can live in the home or turn it into a rental and maintain the same low taxes the parents enjoyed. This transfer has unlimited value for a primary residence and “non-principal residence” (rentals or other homes) is limited to $1 million of assessed value per person. A married couple can transfer $2 million in assessed value. This means a property worth $3 million but a tax assessed value of $750,000 can be transferred to the children.
What changes with Prop 19?
Under Prop 19 any primary residence gifted to children will require the children to maintain that as their primary residence for the remainder of their life. If they turn the property into a rental or live in another home, that will trigger a tax reassessment on the property creating larger property taxes. The exemption amount is lowered to $1 million and applies ONLY to primary residences. The non-primary residence home exclusion is eliminated and will trigger a tax reassessment.
1. Primary Residence
Assume you bought a home twenty-five years ago and today it is worth $2.4 million but has a tax assessed value of $400,000. Under current law, the home can be transferred to your children during your life or at death and they will maintain the tax basis of $400,000 and can live in the home or turn it into a rental.
Under Prop 19, once the home is transferred to your children, one of them must live in the home immediately and maintain it as a primary residence indefinitely to avoid a tax reassessment. Since the home is worth more than the $1 million new exemption, it would trigger a new tax assessed value. The new tax assessed value would be $1.4 million ($2.4 million value – $1 million exemption) instead of $400,000.
2. Rental Property
Assume you bought a rental property twenty-five years ago and today it is worth $2.4 million but has a tax assessed value of $400,000. Under current law, the home can be transferred to the kids and they maintain the $400,000 tax assessed value since a couple can use exemptions up to $2 million in tax assessed value.
Under Prop 19, the “non-principal value” exemption is eliminated so it would trigger a large tax assessment and the kids do not retain the $400,000 tax assessed value.
What should you do?
If you own a home in California with a low tax basis and would like to keep the property in the family, talk with us and your estate planning attorney today to explore if you should consider gifting the property before the February 16th deadline when Prop 19 takes effect. If you would like to contact us, please speak with your advisor or you can reach us at email@example.com.