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PROPERTY TAX CHANGES DUE TO PROPOSITION 19

 


 
Proposition 19 (Prop 19) recently passed in California and severely limits the conditions under which property owners can transfer California real property between parents and children without triggering property tax reassessment.  Prop 19 takes effect on February 16, 2021 and contains significant changes that may impact your estate planning. 

 
Current Law
 
Under Proposition 13, which was passed by 64.79% of California voters on the June 1978 ballot, California properties are taxed based on their assessed value (also known as the base year value or taxable value) rather than their fair market value. Assessed value is generally the purchase price and cost of improvements, plus an increase of no more than 2% per year unless and until there is a change in ownership. Because California real estate, on average, has appreciated in value at a rate higher than 2% per year, the longer a property is held, the greater the difference between its assessed value and its fair market value, and thus the greater the difference between the amount of property tax its owner pays as compared to the owner of a newly purchased property of equivalent value. 
Transfers between spouses are exempted from the change in ownership rule (and thus from property tax reassessment). In addition, Proposition 58, which was passed by 75.7% of California voters on the November 1986 ballot, excludes from reassessment transfers between parents and children of the transferor’s (a) primary residence, regardless of value, and (b) $1 million of assessed value of other real property (such as second homes and investment properties). Proposition 58 is commonly referred to as the parent-child exclusion.  The parent-child exclusion is most favorable to families that have long-held California real property with low assessed values thanks to Proposition 13. For example, a 60-unit apartment complex in the San Francisco Bay Area purchased by a married couple in 1979 may have an assessed value just under $2 million, although the fair market value of the building is $20 million. Under Proposition 58, the couple could transfer this property to their children without reassessment. (Each parent can transfer property with $1 million of assessed value, and together they can transfer property with $2 million of assessed value.) In addition, the couple could transfer their primary residence to their children without reassessment, regardless of the assessed value.

 
New Law Under Proposition 19
 
Beginning February 16, 2021, Prop 19 eliminates the parent-child and grandparent-grandchild exclusion from reassessment for properties other than a “family home.”  The available exclusion from reassessment for non-primary residence real properties is entirely eliminated.  
Further, under the new law, the parent-child exclusion on the family home is reduced from unlimited value to one million dollars above the current assessed value.  As such, even if a parent transfers his or her primary residence to their child who also uses it as a primary residence, there could still be an increase to property taxes depending on the assessed value of the property.  For example, if your home has increased in value less than or equal to $1,000,000, no adjustment is made.  If the increase in value more than $1,000,000, the increase in value after the first $1,000,000 is added to the tax assessed value. For example, assume a parent's home has a taxable value of $3,000,000. Because the parent purchased the home many years ago, its value is now $5,000,000. In other words, it has increased by $2,000,000. The new reassessed value if the parent gifts the home to her child will be $4,000,000. There are inflation adjustments that apply to the $1,000,000 increase limitation for subsequent years.
The following is a comparison chart of the current parent-child exclusion and the effects of Proposition 19 provided by the California Board of Equalization:

 
 

Note: The above chart is intended to provide general and summary information about Proposition 19. It is not intended to be a legal interpretation, official guidance or relied upon for any reason but instead be a presentation of summary information. If there is a conflict between the information above and the text of the proposition or its implementation, the text of the proposition or legal interpretation will prevail. The above is intended as general information only.
This change to the parent-child exclusion may also affect many common estate planning trusts that were established several years (or even decades) ago. For example, a qualified personal residence trust (QPRT) allows the transfer of a residence to a trust while that residence can still be occupied for a fixed number of years. The parent(s) continue to live in the residence as their primary residence, and at the end of the fixed number of years, the residence transfers to someone else (typically their children or a trust for their benefit). Most parents who establish QPRTs want to continue living in the house after the fixed term ends. They may do so, but they need to pay rent to the trust or to their children, depending on who owns the residence at the end of the fixed term.  Under existing law, when the children become the owners they would qualify for the parent-child exclusion. But once Prop 19 takes effect, the children would need to use the residence as their primary residence or trigger reassessment. They could not rent it back to the parent, and if siblings are entitled to the residence at the end of the fixed term, they would need to move in together and share a household to qualify for the exemption – which perhaps is not ideal for most adult children. If parents have QPRTs whose fixed term ends on or after February 16, 2021, the value of their home may be reassessed to its current value. This could lead to a massive property tax increase.
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