Proposition 13 and Proposition 19 Property Tax Planning
With the approval of California’s Proposition 19, the ability to transfer your home or other real property to your children without property tax reassessment will be significantly reduced. The new law will apply to all transfers of real property on or after February 16, 2021. The time to plan is now. Read more about property tax planning.
Background
Under current law (until February 16, 2021), the assessed value of real property increases by no more than 2% annually. Since the fair market value of California real property has far exceeded the 2% annual adjustment since Proposition 13, owners of California real property enjoy a lower property tax burden compared to owners of newly acquired property. However, when you transfer (gift or sell) real property, the property is reassessed at the current fair market value. California provides two important exemptions from reassessment when transferring real property between parents and children.
Exemption No. 1: A transfer of a 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. It also does not matter whether the child decides to use the home as his or her primary residence, a vacation home or as a rental.
Exemption No. 2: Transfers of other real property interests (residential or commercial) of up to $1 million of total taxable value are exempted from reassessment, regardless of the fair market value of the property at the time of transfer. This $1 million exemption is per transferor/spouse.
New Law Under Proposition 19
Proposition 19 completely eliminates Exemption No. 2. Parents will no longer be able to transfer real property that is not their primary residence to their children without reassessment. If you have a vacation home or rental property, they will be reassessed at the time of transfer to your children. There are different rules for LLCs.
Proposition 19 also limits the use of Exemption No. 1. 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 taxable value is then determined based upon whether the property’s assessed value (fair market value) at the time of transfer is greater than the parent’s taxable value by more than $1 million. If the assessed value of the property at the time of the transfer exceeds the parent’s taxable value by less than $1 million, then the child assumes the parent’s current taxable value. If the assessed value of the property at the time of the transfer exceeds the parent’s taxable value by more than $1 million, then the child’s taxable value is the current assessed value of the property less $1 million.
Example: Taxable value is $500,000 at the time of transfer. Assessed value (fair market value) is $2.2 million at the time of transfer. Since the assessed value is more than a million dollars greater than the taxable value ($2,200,000 – $500,000 = $1,700,000), the property will be reassessed. The new taxable value will be $1.2 million ($2.2 million less $1 million).
Planning Opportunities Before February 16, 2021
The law does not go into effect until February 16, 2021. This leaves little time to plan, however, there is an opportunity to transfer assets prior to February 16.
Who should plan? If you have a second home, rental real estate, or commercial property, you should seriously consider the transfer of those properties to trusts for your children now. You can transfer up to $1 million of property at its taxable value (the value shown on the property tax roll) to trusts for your children without reassessment.
Additional benefits. There is concern that the estate tax exemption could come down significantly under a Biden presidency. By transferring the assets now, the property is excluded from your estate for estate tax purposes. Also, by transferring the property in trust now, you could provide asset protection for you and your children.
What do you give up? If the property is income-producing, the income tax will be attributed to either you or your child, but the income will no longer be available to you (at least not directly). Also, the transfer of the property may result in a carryover basis (depending upon how it is structured). Carryover basis means that your cost basis in the property will transfer to your child. Although this is not ideal, you can control when the property is sold; you can’t control when you pass away. Moreover, the laws allowing for a step-up in basis at death may change in the near future and would eliminate any benefit to keeping the property until your passing. There are ways to still receive a step-up in basis, depending upon your ultimate goals.
Other considerations? Many of you own your rental property in LLCs. Depending on how you acquired the property, the transfer of the LLC to your children could also cause a property tax reassessment. Long story short, if you purchased the property in your name, and then later transferred it to an LLC, the property will be reassessed upon your passing. There are still opportunities to eliminate reassessment in this situation.
When should you plan? Now! We only have a couple of months to prepare plans and complete the transfers. Contact Modern Wealth Law today at (949) 371-5003 – Serving Orange County.
John Wong advises on all aspects of estate planning, probate, asset protection and trust administration. He believes that estate planning is about planning for life; while having protections in place should the unexpected occur.
