This year California voters surprisingly passed Proposition 19 entitled the “Home Protection for Seniors, Severely Disabled, Families, and Victims of Wildfire or Natural Disasters Act.” In a classic case of “don’t judge a book by its cover,” its reach extends far beyond those who were unfortunate to lose a home in a fire. This Act amended the California Constitution. It becomes effective on April 1, 2021, for replacement of primary residences and February 16, 2021, for transfers of ownership. Many fear that Proposition 19 may open the door to further weakening, if not outright elimination, of Proposition 13 down the road.
Proposition 19 has two significant features:
1. Retain Current Property Tax Assessment in Certain Situations. Proposition 19 allows homeowners who are either over 55, have severe disabilities, or are victims of natural disasters or hazardous waste contamination to purchase a new residence but retain their property tax assessment from a prior home.
2. Significantly Modifies Proposition 58 and Proposition 193 Reassessment Exemptions. Proposition 19 limits the applicability of the parent-child (Proposition 58) and grandparent-grandchild exclusions (Proposition 193) from property tax reassessment to properties that will be used as the recipient’s personal residence only.
In order to truly understand the far-reaching implications of Proposition 19, it is important that we understand how the landmark Proposition 13 works. Here is a quick summary:
- Property taxes are based on market value when you first purchase a home.
- Lowered property taxes to 1% of the full value of the property.
- A maximum tax increase of 2% per year regardless of the value of the property.
- A reassessment occurs when the property ownership changes (unless an exemption applies) or there is construction done.
The Good News
Retain Current Property Tax Assessment in Certain Situations
Current Proposition 60 allows seniors who own a home to purchase a replacement residence that is equal to or lesser in value from the original property, and retain the original property tax assessment under Proposition 13. But, Proposition 60 does not benefit many in that seniors may only utilize this benefit one time. Additionally, the replacement property must be located in the same county as the original property, unless the original and replacement properties are in two of the ten counties that have agreed to an intercounty base year value transfer.
Beginning on April 1, 2021, Proposition 19 extends the persons who are eligible to retain their property tax assessment beyond seniors to persons with severe disabilities and victims of natural disasters as well as toxic waste contamination. It also permits the replacement property to be worth more than the original property. The assessment will be adjusted based on the difference in fair market value between the two properties. Lastly, it allows homeowners to change properties up to three times during their lifetime and within any county in California. Since seniors typically rely on fixed incomes, Proposition 19 allows for more freedom by giving them the option to purchase their new home, to downsize or be closer to loved ones.
The Bad News
Significantly Modifies Proposition 58 and Proposition 193 Reassessment Exemptions
Current Proposition 58 allows property owners to transfer their property to and from a parent or a child, by purchase, gift, or inheritance, with the recipient retaining the original owner’s property tax basis. There is no value limit on the exemption from reassessment provided the property has served as the original owner’s personal residence. There is a $1 million dollar exemption from reassessment for all other transferred property. Current Proposition 193 extended Proposition 58 to certain qualifying transfers between grandparents and grandchildren.
Beginning on February 16, 2021, Proposition 19 limits the applicability of the parent-child and grandparent-grandchild exemptions to transfers of a home or a family farm that will be used as the personal residence of the recipient. If the property’s fair market value at the time of transfer is less than $1 million greater than its assessed value, the property will retain its original assessed value. If the property is worth more than $1 million over the assessed value, only $1 million is excluded from property tax reassessment. The parent-child and grandparent-grandchild exclusion for any real estate other than a personal residence has been eliminated.
What to do about it?
This law will have a substantial impact on those who intend to transfer properties such as vacation homes and commercial buildings to their children at death at the low property Proposition 13 tax basis. You may be inclined to hastily gift a property to a child prior to February 16, 2021, to take advantage of the benefits of the prior law and the high $11.58 million estate and gift tax exclusion.
If it could only be as simple as just signing a deed. You must weigh the pros and cons before deciding on a course of action. There are numerous moving parts and a thorough mathematical analysis must be completed. If the transferee is going to want to keep the property for the long haul, then the scales tip in favor of retaining the current Proposition 13 tax basis and transferring the property before February 16, 2021. If the property is highly appreciated and the transferee is likely to want to sell the property as soon as they receive upon death, then the scales tip in favor of retaining the full step-up in basis for capital gains tax purposes and not gifting the property prior to February 16, 2021. (How to Defeat Capital Gains Tax blog post).
Gifting a property will also result in the loss of control. An outright gift will also expose the property to the creditors and whims of the transferee. Gifted properties will need to be appraised and a Form 709 (Federal Gift Tax Return) will need to be filed. Many of these concerns can be eliminated if a property is transferred to an Irrevocable Trust. The costs and fees associated with transferring a property properly must also be considered.
We anticipate that legality of Proposition 19 will be challenged in court. Moreover, legal work-arounds may become available between now and its implementation. Accordingly, we will post updates to this blog.