California Proposition 19, which appeared on the November 3, 2020, ballot, appears likely to pass. The measure currently has a 51.1% “Yes” vote, although all votes have not been counted and the results of the election have not yet been certified. If passed, the ability to transfer California real property between parents and children without a property tax reassessment will be significantly more limited than under current law.
Current Law on Parent-Child Transfers of California Real Property
Under current law, a parent can transfer (1) his or her California principal residence and (2) other California real property of up to $1 million of assessed value (not fair market value) to his or her children without triggering a property tax reassessment. The “parent-child” exclusion:
- Applies not only for a transfer from a parent to child, but also to a transfer from a child to parent.
- Applies whether the transfer occurs by gift or sale, during lifetime or at death or outright or through a trust.
- For the transferor’s principal residence (a) may be used more than once, (b) applies without regard to the assessed value or the fair market value of the residence, (c) applies without regard to whether the transferee intends to use the residence as his or her own principal residence.
There is also a “grandparent-grandchild exclusion” providing for similar exclusions that applies only to a transfer from grandparent to grandchild where the intervening child/parent has died.
Impact of Proposition 19 on Parent-Child Transfers of California Real Property
If Proposition 19 is enacted, as appears likely, effective for transfers on or after February 16, 2021, (1) the parent-child exclusion will apply only in a limited fashion to the transferor’s principal residence, discussed in detail below, and (2) the $1 million of additional property prong under current law is eliminated entirely.
Under Proposition 19, the parent-child exclusion will be available for transfers of a parent’s (or child’s) principal residence to a child (or parent) who, immediately after the transfer, will use the residence as his or her principal residence, a requirement that will be difficult to satisfy for a lifetime transfer. Any transfer that does not meet these requirements will cause the transferred residence to be reassessed to fair market value at the time of the transfer.
Even if the principal residence requirement is satisfied by both parent and child, the exclusion is no longer unlimited in value and will only exclude up to an additional $1 million of value (indexed for inflation based on the California House Price Index) over the existing assessed value of the residence. Thus, the value of the residence in excess of its assessed value at the time of transfer plus the additional adjusted $1 million of excluded value will be reassessed to current market value.
The new rules can be illustrated by the following example. Assume that the assessed value of the residence is $600,000 and, at the time of transfer, the adjusted $1 million exclusion is $1.1 million. If the fair market value of the residence on the date of transfer is $1.7 million (equal to assessed value of $600,000 plus $1.1 million adjusted exclusion) or less, then there will be no reassessment. If, instead, the fair market value of the residence on the date of transfer is more than $1.7 million, there will be a partial reassessment. Thus, if the fair market value of the residence is $2.5 million, the assessed value of the residence will be increased by $800,000 (equal to $2.5 million less $1.7 million) to a new assessed value to the transferee of $1.4 million (equal to $600,000 assessed value to transferor plus $800,000) adjustment.
Other Proposition 19 Changes
While Proposition 19, if enacted, will significantly limit the ability to transfer California real property between parents and children without a property tax reassessment, effective on or after April 1, 2021, it will expand the current rules allowing homeowners age 55 and older, disabled homeowners and victims of natural disasters to sell their existing home and purchase a new home while maintaining their existing property tax base. Proposition 19 allows qualifying homeowners to utilize this property tax relief provision up to three times, whereas the exception under current law can be used only once. Additionally, Proposition 19 includes a mechanism to provide property tax relief even if the value of the new home exceeds the value of the existing home, whereas under current law the exclusion is limited to a home of equal or lesser value. Finally, the relief under Proposition 19 is afforded to qualified homeowners throughout the State of California and is no longer limited to certain counties as under current law. The California State Board of Equalization has provided a detailed summary of the current property tax law as compared to the property tax law under Proposition 19.
Planning Considerations in Light of Proposition 19
Clients intending to transfer ownership of California real property utilizing the parent-child exclusion from property tax reassessment should consider completing such transfers before February 16, 2021. Numerous irrevocable trusts, including Qualified Personal Residence Trusts (QPRTs), Marital Trusts and Credit Trusts (Bypass Trusts), rely on planning structures that, under current law, would have allowed a parent-child exclusion from reassessment when California real property held by the trust passes to children pursuant to the terms of the trust. Following enactment of Proposition 19, it is unlikely that the parent-child exclusion can be claimed for these transfers. With the ability to directly transfer California real property between parents and children without reassessment severely limited after February 16, 2021, clients will need to rely more heavily on planning structures that use business entities to acquire, hold and transfer real property that are unaffected by Proposition 19 and may allow for continued property tax savings with proper planning.