We hope that you are all doing well and staying healthy during these difficult times. The purpose of this letter is to bring to your attention the recent significant change to the real property tax laws. Specifically, on November 3, 2020, California voters approved Proposition 19 which will impact property taxes on real estate transferred to a child after February 16, 2021.
In California, a real property owner generally will pay property taxes based on the property’s assessed value determined at the time of purchase. (There are, of course, some exceptions to this rule). The result is that an owner of real property that has appreciated over time will continue to pay lower property tax based upon the original assessed value at time of purchase, and not the current value of the appreciated real property.
To understand the change in the law, it is important to differentiate transfers of your home to your child versus transfers of your other property to your child. It is also important to demonstrate the difference between the current law and the new law that goes into effect on February 16, 2021.
Transfers of Your Home to Your Child
Under the current law, a child (and in some cases a grandchild) could acquire the parents’ residence and pay the same lower property tax that was paid by the parents. This benefit applies regardless of the value of the residence on the date of the transfer and regardless of whether the child elects to live in the residence. In other words, the child could, for example receive the parents’ $5,000,000 residence, use the residence as a rental and still pay the same lower real property tax that was paid by the parents.
Under Proposition 19, parents can transfer their principal residence’s current assessed value only if a child will also occupy the property as their principal residence. Therefore, if a child acquires the parents’ residence and does not reside in the residence, the property will be reassessed at its current market value.
Additionally, even if the child elects to reside in the residence, the parent to child exclusion under the new law is limited to $1,000,000 of exclusion of fair market value above current assessed value. For example, assuming the parents assessed value was $500,000 and the fair market value of the residence, when transferred, is $5,000,000, $3,500,000 of this value will be reassessed.
Transfers of Your Other Property to Your Child
Under current law, parents can transfer up to $1,000,000 of assessed value of other real property (vacation, rental, etc.) to their child. Under Proposition 19, any transfer of other real property will result in a full reassessment for property tax purposes.
What Can You Do?
If you transfer real property before February 16, 2021, you may be able to take advantage of the current parent to child exclusions under the current law; i.e., you can transfer your home to your child without reassessment regardless of whether they intend to reside in the residence and you can transfer up to $1,000,000 of other property without reassessment. HOWEVER, it is important to understand that transferring real property prior to February 16, 2021 may not be right for you
First, you may not be interested in gifting any of your real property to your child, especially your home. Afterall, this is an irrevocable gift. If this is the case, you do not need to take any action to avoid Proposition 19.
Second, your child may not be interested in keeping the real estate. The purpose of using the parent to child exclusion is to ensure that your child can pay the lower annual property tax while they own the property. If your child does not intend to keep the real estate, then there is likely no reason to transfer the real property to your child prior to February 16, 2021 to avoid Proposition 19.
Third, if you transfer real property to your child during your life, your child will not get the benefit of a step up in basis for capital gains purposes on your date of death. Stated in simple terms, if you buy property for $100,000 (your basis) and you sell that property for $1,000,000, you will be required to pay capital gains tax on that gain at the time of sale ($900,000). If you gift that property to your child during your life, your child will acquire your capital gains basis of $100,000. When that child later sells the property for $1,000,000, the child will pay capital gains tax on the difference between the $1,000,000 sale price and the $100,000 basis.
Conversely, if you gift that property to your child on your date of death and the property has a value of $1,000,000 on your date of death, your child will acquire a new basis in the property that is equal to the date of death value of $1,000,000. Thus, when your child sells the property later for $1,300,000.00, your child will pay capital gains tax on $300,000 (the difference between the date of death value and the sales price) and not on $1,200,000 (the difference between the date of death value and the sales price).
What this means is that if you elect to gift real property to your child prior to February 16, 2021, your child will not get the benefit of the step up in basis on your date of death. If your child later sells the property, the child will pay capital gains on the difference between the sales price and your basis.
For this reason, real property should not be transferred if your child is likely to sell the real property.
Fourth, you may have mortgages and liens on your real property. Often times, the lender will not allow the property to be transferred to your child or the loan will be called.
Please understand that these are just hypotheticals and general concepts and your personal situation may differ greatly from these hypotheticals for a variety of reason. Other tax and legal matters may come into play. You should consider discussing these concepts with your tax professionals to determine how Proposition 19 will affect you.
Contact Our Office
This law is new, and we continue to try to understand its implications. However, if you believe that you may want to transfer property to your child prior to February 16, 2021, please contact our office to schedule a consultation. This is also a good time, as always, to reevaluate your estate plan. We will gladly schedule a general estate plan review as well.
Again, I hope that you remain safe and healthy and I wish you a Happy Holiday Season.