What is Proposition 19?
Proposition 19 is a measure to change Props 13 and 58 in California. As you probably know, Proposition 13 passed in 1978 and limited property tax increases to 2% annually unless reassessed due to sale or other transfer. Because of Proposition 13, property tax valuation of properties in California is much less than the actual current market value. Proposition 58, passed in 1986, authorized the owners of property to transfer property to their children and grandchildren with the same low property tax basis. This affects the personal residence (regardless of value or who will live there) plus $1Million in additional property.
Current California law also allows a qualified homeowner (aged 55 or over, disabled, or a natural disaster victim) to move to a participating in-state county once, and carry the assessed value of their property with them when moving to a home with a lower assessed value.
How Does Proposition 19 Change Property Taxes?
Proposition 19 amends the current legislation adopted in Propositions 13 and 58. It allows qualifying owners (over 55 years of age, physically disabled or natural disaster victims) to move into a house of lesser value up to three times in the State and to carry their lower property tax assessments. This is great news for homeowners, but you should be aware; Proposition 19 also amends the law on inheriting property. Under proposition 19, all real estate will be reassessed at death, with the exception of a primary residence worth less than $1 million that a child actually moves into (if worth over $1M the balance is reassessed).
Again, before Proposition 19 goes into effect on February 16, 2021, property owners can leave or gift their primary residence and up to $1 million in assessed value of other real estate to their children (and qualifying grandchildren) and the assessed value would transfer with the property. Under Proposition 19 the preferential valuation can only be transferred under the following conditions:
How Will This Look for Me?
Let’s look at a case in point:
Amy owns her first home, now worth $2 Million, with an assessed value of $300,000. She pays $3,600 a year in property taxes. The property tax would be approximately $24,000 a year if it were to be reassessed at current fair market value. Amy also has rental home with a cost basis of $250,000 and $1.2 million current valuation. The property taxes Amy pays are $3,000 a year for the rental, but the property tax would be about $14,400 if it was assessed at current fair market value. Amy is planning on leaving her property to her son David.
Before Proposition 19, if Amy dies, David would pay the same property taxes that Amy had been paying, totaling about $6,600 per year. Just as with Amy, property taxes will increase only 2% per year. After Proposition 19, once the properties pass to David, they will be reassessed to about $26,400 if David moves into the house, or $38,400 if David does not move into Amy’s house.
What Can You Do Now?
So what do we recommend someone like Amy do? Proposition 19 will go into effect on February 16, 2021, so before that date, Amy should consider transferring one or both properties to David. If Amy does this, David will not face the reassessment to fair market value of the property and would not have to move into Amy’s home.
Such transfers must be made by February 15, 2021. Any transfers after February 15, 2021 will be subject to the rules of Proposition 19. There are very serious downsides to making real property gifts. First, you would have to file a gift tax return using part of your $11,580,000 lifetime gift and estate tax credit to avoid paying taxes on this gift. This may be a very good use of the $11,580,000 credit, which is set to drop by 50% in 2025, if not lowered sooner by the new administration.
The second major consideration is cost basis. When you gift property, the recipient keeps your lower cost basis. When you die, your heirs get a stepped-up basis, which would allow them to sell real property with no capital gains tax, or depreciate income property as it if just purchased. This is a huge tax benefit that must be considered when making gifts. A gifting strategy would clearly work best for a valuable primary residence (worth over $1 Million) that your child plans to live in, then pass along to his or her heirs. You can avoid gift taxes using your lifetime credit, there would be no capital gains tax as the property will not be sold during your child’s lifetime, and your low property taxes have been preserved.
One possible strategy is available for other property, such as rentals, commercial property and land. Consider transferring the property into a corporation or LLC, then your children or grandchildren can inherit shares of the business and there will be no change of ownership on the actual deed to trigger reassessment. This is a current loophole that the counties will try to close, and may or may not be an effective tool for avoiding reassessment.
Other benefits of this strategy are (1) asset protection (2) advanced gifting opportunities by giving stock/shares (3) possible estate tax reduction in the value of the property owned by the business entity if you do not own 100% of the shares/stock by gifting shares/stock to your heirs, and (4) no February 2021 deadline. This is a complicated and important issue. Proceed carefully and make informed decisions together with an attorney and CPA. Personal residence gifts must be made before February 16, 2021, to take advantage of Prop 13.
Will Proposition 19 affect your family? Consider if it makes sense for you to gift your home or move the property into a business entity.