The passage of Proposition 19 has significantly restricted the ability of parents to transfer low assessed values of real estate to children.
What does this mean for your property taxes and the inherited property taxes of your children?
The Proposition was sponsored by the California Association of Realtors. Why would realtors support this bill? The idea is that a child inheriting property with a big property tax bill is more likely to sell the property, thereby making more real estate available for sale and more commissions available for realtors. A benefit of the new law is that the tax revenue will support the state's wildfire relief efforts, which as we all know is much more needed than in years past.
“I made my money the old-fashioned way. I was very nice to a wealthy relative right before he died.” — Malcolm Forbes
Parent to Child Transfers
Under the current law, parents can transfer the tax basis of their primary residence plus $1 Million of additional real estate (ie vacation homes or commercial property) to children by making a gift or transferring the property at death.
Under Prop 19, which goes into effect February 16, 2021, parents can only transfer the current tax basis of the primary residence if a child claims the home as his or her primary residence. Furthermore, if the child does claim the home as his or her primary residence, the child only receives the tax basis of the parent plus $1 Million of the fair market value on top of the current assessed value of the residence. Parents can no longer transfer the tax basis of any other real estate to their children.
Here is an example to illustrate.
Under current law, Dad owns a residence with a fair market value of $2 million. His assessed value (that adjusted base-year value) is $500,000. If we use 1.25% as an estimated rate of property tax, then Dad pays $6,250 per year in property tax. When Dad dies, his daughter June inherits the house and receives the $500,000 assessed value. June continues to pay the same amount of property tax as her Dad, which is $6,250 annually.
Under Prop 19, Dad owns a residence with a fair market value of $2 million with an assessed value of $500,000. When Dad dies, his daughter June inherits the house and does NOT make it her primary residence. June will pay property tax based on the fair market value of $2 million and she will pay $25,000 a year in property tax. If June DOES make it her primary residence, then June will be taxed as if the property she inherited was worth $1 million. The calculation is this: she pays taxes on the current fair market value of the house ($2 million) - $1 million because that fair market value ($2 million) is more than Dad’s assessed value ($500k) plus $1 million ($1.5). If we use 1.25% as an estimated rate of property tax, her property tax bill will be $12,500 annually rather than $6,250 under the current law.
Source for Image: https://www.boe.ca.gov/prop19/
PROS TO TRANSFERRING PROPERTY TO YOUR CHILD(REN) NOW:
If the property taxes will significantly increase and your child would not be able to afford them, the transfer now can lock in your property tax rate for your child.
If your spouse has passed, and you’ve recently received a full step up in basis and want to start “winding down” your own property management work, it may make sense to accelerate this transfer. You can transfer up to $1 Million of assessed value in real estate that is not your primary residence prior to February 16, 2021.
If you know your child does not want to sell your additional real estate after you die. For example, if it is a family second home or cabin with sentimental value, or if your child will continue renting the property as a major source of income, a transfer now will lock in (under current laws) the lower property taxes.
CONS TO TRANSFERS:
Loss of step up in capital gains. If your property has significantly increased in value, when you transfer the property in your lifetime to your child the property maintains your basis. If your child then later sells the property, the gains will be calculated based on your basis/purchase price (more specifically, your basis is calculated as the original parent purchase price plus any improvements, and adjustments for any depreciation taken or that could have been taken.) If the property has gone significantly up in value your child’s capital gains taxes will eat into profit.
If you do not want to relinquish control of your rental properties, or do not feel your adult child can and wants to take on this responsibility. The transfer is irrevocable, so only make this irrevocable gift or transfer if you are prepared to relinquish control.
File a gift tax return (709) with IRS to report this gift. This won’t create a taxable event necessarily, but it is a reporting requirement.
If you are concerned about the impact of Proposition 19 on your estate planning, please contact our office today for a consultation to discuss your specific situation and any strategies to mitigate the impact of this new law on your family's legacy.
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