If you own a property, you’re likely very familiar with the concept (and payment) of property taxes. Property taxes are due annually when you own a piece of real property (land/building) and are generally based on the assessed value of your property at the time you bought it, plus adjustments for inflation.
Typically the initial assessed value (or taxable value) is equal to the purchase price.
The property tax rate is capped at 1% of the assessed value of the property, adjusted annually for inflation. Each time the property is sold or transferred the property’s value is reassessed and adjusted to the new purchase price or appraised value – unless it’s inherited by a child or grandchild. But that exception just got a whole lot tighter under Prop 19, which goes into effect in February of 2020.
Prior to Prop 19’s passing this November, a “parent child exclusion” existed for transfers of real property between parents and children (and grandchildren in some cases). Specifically, CA Prop 13, passed in 1978, stated that the county could not reassess a property transferred between a parent and a child in most scenarios. The law allowed for children to inherit property, under the following circumstances, with no reassessment. This meant exceedingly low property taxes could be passed down for generations:
- One Property of any value, as long as the child made that home his or her Primary Residence.
- Any Additional Properties, up to $1 million in value.
Prop 19 effectively wiped away the extra million dollars for “additional properties” and limited the property tax exclusion for inherited primary residences.
Before we get into the specifics of how Prop 19 limits the property tax exclusion on inherited homes, here’s an example of the general effect of Prop 19 on inherited properties:
Mom and Dad live in the SF Bay Area and create a Revocable Trust. Mom and Dad own two homes:
- Primary Residence Bay Area
- Vacation Home in Yosemite
In the Trust, Mom and Dad leave both homes to their two grown children, Bob and Kate.
Under current law (and until February 2021), if Mom and Dad die, Bob and Kate could potentially keep both homes without triggering a property tax reassessment. In order to do this, Bob or Kate would have to make the primary residence his or her primary residence, and the vacation home would have to be less than $1 million.
Let’s say Kate decides to move her family into Mom and Dad’s primary residence, making it her own primary residence. Great! Whatever Mom and Dad were paying in property taxes each year, Kate will now pay. Mom and Dad’s property has increased in value significantly over time, so Kate is privy to a huge savings each year, since her property tax is based on a much, much lower home value than were she to buy the home in today’s market.
Kate and Bob agree on a buyout to make up the difference between the Vacation Home and the Primary Residence, and Bob decides to keep the Vacation Home as an income property. As long as the Vacation Home’s value is under $1 million, Bob too will see no increase in property taxes.
Under this scenario, it is financially more tenable to hang on to inherited properties.
Now that Prop 19 has passed, if the same situation occurred and Kate decided to move into Primary Residence (and make it her primary residence), there would be no exclusion for Vacation Home. And, if the primary residence’s current value exceeds the value at the time mom and dad bought it by more than $1 million, property taxes will go up there as well. More on that in a minute.
Prop 19 therefore make is a lot less easy to hang on to Vacation Home, especially if the Vacation Home has substantially increased in value.
And, if Mom and Dad’s primary residence has increased in value by over a million, it just got more expensive for Kate to own the home.
So what’s the bottom line of Prop 19 for inherited properties?
- If no children wish to live in the parent’s primary residence, that child, or children will have to bear the burden of paying property taxes based on today’s market value. Before, they had up to $1 million in property value that could be excluded from a property tax reassessment.
- If a child does wish to live in the primary residence, his or her exclusion will potentially be limited by the current value of the home.
Quick Note on the “Parent Child Exclusion” – it also applies to Grandparents and Grandchildren when there are no living Parents.
Now, many children will still be able to inherit the family home while maintaining their parents’ property tax base. They will see no increase in property taxes due to the transfer of the home and death of the parent. It’s only when a property goes significantly north of $1 million in today’s market that children will have to pay increased property taxes. But, as the law outlines, most of those increases will still result in the child paying significantly less than he or she would if buying the house on the market today.
Many of our clients want to know if they should adjust their Estate Plans due to Prop 19. They also want to explore the possibility of transferring their home to a child prior to February of 2021, when Prop 19 becomes effective.
Unfortunately there’s no magic estate planning tool that circumvents Prop 19 like Irrevocable Trusts can for Federal Estate taxes (well, at least not anything so reliable). But, some families can benefit from taking action before February 2021.
However, it should be noted that there are some potential very large pitfalls of transferring your home to your child prior to your death:
- Potential Estate Litigation due to pre death transfer and/or unequal distributions to children due to transfer
- If the child decides to sell the home at any point, he or she loses the (potentially huge) capital gains tax savings
- You’ve just given away your property and your child is free to take out loans against it without your knowledge (!!)
All in all, Prop 19 still preserves benefit and intent of Prop 13 for inherited properties – ie families of more modest means can still pass down homes to their heirs without a property tax reassessment.
Families of more substantial means, however, will no longer get the benefit of a low tax base for multiple properties.
For questions about Estate Planning and Prop 19, call our Trust and Estate Law Firm in Walnut Creek at 925-322-1795.
And if you want to read the new law as far as it pertains to inherited properties, scroll down and enjoy! We’ve added a couple definitions for better understanding.
(h) inoperative February 16, 2021, pursuant to Section 2.1:
(h) (1) For purposes of subdivision (a), the terms “purchased” and “change in ownership” do not include the purchase or transfer of the principal residence of the transferor in the case of a purchase or transfer between parents and their children, as defined by the Legislature, and the purchase or transfer of the first one million dollars ($1,000,000) of the full cash value of all other real property between parents and their children, as defined by the Legislature. This subdivision applies to both voluntary transfers and transfers resulting from a court order or judicial decree.
“Taxable value” = assessors tax roll value.
“Assessed value” = Fair Market Value at the time of the transfer.
(c) Property Tax Fairness for Family Homes. Notwithstanding any other provision of this Constitution or any other law, beginning on and after February 16, 2021, the following shall apply:
(1) For purposes of subdivision (a) of Section 2, the terms “purchased” and “change in ownership” do not include the purchase or transfer of a family home of the transferor in the case of a transfer between parents and their children, as defined by the Legislature, if the property continues as the family home of the transferee. This subdivision shall apply to both voluntary transfers and transfers resulting from a court order or judicial decree. The new taxable value of the family home of the transferee shall be the sum of both of the following:
(A) The taxable value of the family home, subject to adjustment as authorized by subdivision (b) of Section 2, determined as of the date immediately prior to the date of the purchase by, or transfer to, the transferee.
(B) The applicable of the following amounts:
(i) If the assessed value of the family home upon purchase by, or transfer to, the transferee is less than the sum of the taxable value described in subparagraph (A) plus one million dollars ($1,000,000), then zero dollars ($0).
(ii) If the assessed value of the family home upon purchase by, or transfer to, the transferee is equal to or more than the sum of the taxable value described in subparagraph (A) plus one million dollars ($1,000,000), an amount equal to the assessed value of the family home upon purchase by, or transfer to, the transferee, minus the sum of the taxable value described in subparagraph (A) and one million dollars ($1,000,000).
(2) Paragraph (1) shall also apply to a purchase or transfer of the family home between grandparents and their grandchildren if all of the parents of those grandchildren, who qualify as children of the grandparents, are deceased as of the date of the purchase or transfer.
(3) Paragraphs (1) and (2) shall also apply to the purchase or transfer of a family farm. For purposes of this paragraph, any reference to a “family home” in paragraph (1) or (2) shall be deemed to instead refer to a “family farm.”