2020 Tax Planning: Consider Transfers of California Legacy Properties in Light of Proposition 19

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Proposition 19, which will be on California’s November 2020 ballot, dramatically changes the property tax rules exempting certain intra-family transfers and primary residence transactions for certain individuals such as those over age 55 or severely disabled.[1] This memo illustrates the impact of the proposed change for properties transferred between parents and children, which could significantly increase the cost to future generations of keeping legacy properties within the family.[2]

California property tax is assessed based on the property’s purchase price and the cost of any improvements to the property. Unless a “change of ownership” occurs, the assessed value of real property increases by no more than 2% annually. Because average appreciation of California real property has far exceeded the 2% annual adjustment since the enactment of Proposition 13 in 1978, long time owners of California real estate generally enjoy a very low property tax burden relative to owners of newly acquired property. California currently provides two valuable exemptions from reassessment, which allow the continuation of this benefit after transfers of qualifying property interests between parents and children.[3] First, a transfer of parent’s principal residence to a child is completely exempted from reassessment. The child succeeds to the parent’s assessed value regardless of the value of the property or its assessed value at the time of transfer. Second, transfers of real property interests which are not the parent’s primary residence (residential or commercial) are exempted from reassessment to the extent of $1 million of assessed value, regardless of the fair market value of the property.

Proposition 19 revises the Parent-to-Child Exemptions to limit (1) the types of transfers between parents and children that can be exempted from reassessment, and (2) the property tax benefit available. First, only a transfer of the parent’s principal residence to the child where the property continues as the child’s principal residence qualifies. Second, provided the transfer meets the principal residence requirements, the child’s assessed value is then determined based on whether the property’s value at the time of transfer is greater than the parent’s assessed value by more than $1 million. If the value of the property at the time of the transfer exceeds the parent’s assessed value by less than $1 million, then the child takes the parent’s assessed value. If the value of the property at the time of the transfer exceeds the parent’s assessed value by more than $1 million, then the child’s assessed value is the current value of the property less $1 million. The following hypotheticals illustrate the consequences under current law versus Proposition 19

Hypothetical No. 1 – Prop 19 Increases Taxes 10x

Facts:

  • Property #1 is Mom’s principal residence: $10M FMV, $500,000 assessed value
  • Property #2 is Mom’s secondary residence: $5M FMV, $1M assessed value
  • Mom’s total assessed values that she pays property tax on is $1.5M
  • Property tax rate is 1.25% (estimated)
  • Mom’s estimated total property taxes are $18,750
  • Mom gives Property #1 and Property #2 to Child and claims exemption
  • Child does not use either property as principal residence

Child’s Assessed Values and Property Tax Consequences:

Current Law Proposition 19
Property #1 assessed value $500,000 (exempt under R&T Code Section 63.1(a)(1)(A))

Property #2 assessed value $1M (exempt under R&T Code Section 63.1(a)(1)(B))

Properties #1 and #2 are both reassessed to their fair market value because of the requirement the property be both Mom and Child’s principal residence before and after transfer, respectively
Assessed value is $1.5M, total, same as Mom’s Assessed value is $15M, total
Property tax is $18,750, total, same as Mom’s Property tax is $187,500, total

Hypothetical No. 2 – Prop 19 Increases Taxes 9.3x

Facts:

  • Same facts as Hypothetical No. 1, except that Child maintains Property #1 as Child’s principal residence after the transfer.

Child’s Assessed Values and Property Tax Consequences:

Current Law – same result as Hypothetical No. 1 Proposition 19
Property #1 assessed value $500,000 (exempt under R&T Code Section 63.1(a)(1)(A))

Property #2 assessed value $1M (exempt under R&T Code Section 63.1(a)(1)(B))

Property #1 receives a limited exemption from reassessment of the fair market value, less $1M ($10M – $1M = $9M)

If Property #1 FMV were instead $1M then the assessed value would remain $500,000 and Child would have same property tax as Mom for Property #1

Property #2 is reassessed to its fair market value because of the requirement the property be both Mom and Child’s principal residence

Assessed value is $1.5M, total, same as Mom’s Assessed value is $14M, total
Property tax is $18,750, total, same as Mom’s Property tax is $175,000, total

If Proposition 19 passes, it will apply to any transfer after February 15, 2021.

[1]           Note that Prop 19, if passed, would expand the ability of certain homeowners, such as those over age 55 or severely disabled, to transfer the assessed value of their principal residence to a replacement residence and likely provide property tax savings to such homeowners.  In particular, Prop 19 would allow such a transfer of assessed value to a replacement residence in any California county.

[2]              R & T Code Section 63.1 provides the “Parent-to-Child” exemptions. The Parent-to-Child exemptions are for transfers “between” parents and children. The Parent-to-Child exemptions are also available for transfers between grandparents and grandchildren in certain circumstances. For purposes of this illustration, “parent” is the transferor and “child” is the transferee.

[3]              Note that certain procedural requirements must be satisfied to benefit from these exemptions and that other types of exemptions exist other than the Parent-to-Child transfers.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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