California voters approved Proposition 19 in November 2020, which updates California's long-standing property tax reassessment rules. There are two major provisions of Prop 19:
The first major update limits the scope of Proposition 58, the parent-child exclusion,1 which goes into effect on February 16, 2021. This change, which is discussed in more detail below, (1) eliminates the $1 million assessed value reassessment exclusion as to a parent-child transfer of non-principal residence property and (2) substantially limits the parent-child transfer reassessment exclusion as to a principal residence.
Any gifts under the pre-Prop 19 rules must be made no later than February 15, 2021. Accordingly, some individuals may wish to consider gifting California real property sooner than otherwise planned and transferring to children (or trusts for exclusively children) California real property held in a qualified personal residence trust (QPRT) which terminates later than February 15, 2021.
Transfer of Assessed Value to New Residence
The second major update benefits property owners and goes into effect on April 1, 2021. Generally, this change provides that persons over age 55, individuals with a disability, or victims of a wildfire or natural disaster may transfer the assessed value of their California principal residence to a newly purchased or newly constructed replacement principal residence in any county in California.
These new Prop 19 provisions apply to real property located in California, whether or not you are a California resident. Accordingly, clients with California vacation homes, rental residential homes, or commercial properties (owned outside any corporations, partnerships, limited liability companies, etc.) may wish to look at engaging in this time-sensitive planning.
Updates to Parent-Child Exclusion
For years, Californians have relied on Prop 58 and Proposition 193 (grandparent-grandchild exclusion) to transfer certain California real property to children and grandchildren without property tax reassessment. Until February 16, 2021, parents can transfer ownership of a principal residence of any value and up to $1 million of assessed value (per parent) of non-principal residence property (vacation and rental homes, commercial property, etc.) to one or more children or one or more irrevocable trusts exclusively for one or more children without property tax reassessment.
Prop 19 changes these rules. Starting February 16, 2021, the ability of a parent to transfer up to $1 million of assessed value of non-principal residence property is eliminated. Additionally, transfer of a principal residence is reassessed, in part or in whole, at fair market value unless:
- (i) The child uses the residence as his or her own principal residence; and
- (ii) The fair market value of the residence at the time of transfer does not exceed the transferor's assessed value by more than $1 million.2
If at the time of the transfer the child does not use the residence as his or her own principal residence, then the entire property will be reassessed to its fair market value. If the fair market value of the principal residence exceeds the transferor's assessed value by more than $1 million, then the transferee's assessed value will be the fair market value minus $1 million.
For example, a parent owns a principal residence and commercial building in California. The principal residence has an assessed value of $1 million and a fair market value of $2.5 million. The commercial building also has an assessed value of $1 million and a fair market value of $4 million. The parent wants to transfer the two properties to her child.
- Until February 16, 2021: There is no property tax reassessment on either property. The principal residence can be transferred regardless of its value from the parent to the child and the $1 million assessed value of the commercial building is within the other property limit. The child takes an assessed value of $1 million in the principal residence and $1 million in the commercial building.
- After February 16, 2021: The fair market value of the principal residence exceeds the assessed value by more than $1 million. The child takes an assessed value of $1.5 million ($2.5 million fair market value less $1 million). The child takes an assessed value of $4 million in the commercial building because the property is not a principal residence.
As shown above, planning done prior to February 16, 2021, can have a substantial impact on assessed property values in California. Individuals looking to transfer California real property to their children in the near future will want to work quickly in order to complete the transfer by the effective date.
Impacts on QPRTs
Some clients may already have trusts in place that contemplate future transfers of California real property to children. The most common is a qualified personal residence trust (QPRT), which allows the transferor to reside in her principal residence for a term of years, and at the end of such term the property transfers to her children or a trust for her children.
Absent a legislative change or a successful court challenge, if a QPRT's term ends on or after February 16, 2021, the assessed value of the principal residence will be reassessed to its then fair market value, which could lead to a significant property tax increase. Depending on your goals, applicable trust and estate planning documents, and income tax matters, there may be ways to assist you avoid this issue as to property in an existing QPRT, but you will need to contact your estate planning attorney immediately due to the February 16, 2021, effective date.
Altering Your Estate Plan
Because Prop 19 takes effect on February 16, 2021, there is a short time frame to take the necessary steps to preserve property tax savings for children and grandchildren. Individuals in the following situations should consider acting quickly to take advantage of the current rules:
- You own one or more real properties in California where the current fair market value exceeds the assessed value for property tax purposes.
- You have children and you want the California property to go to your children now or eventually.
- You can make an irrevocable gift of the California property to your children and retain sufficient enough resources to maintain your lifestyle.
- You previously implemented an existing estate planning technique where California property will pass to your children after February 16, 2021.
Benefits of Updated Transfer of Assessed Value Rule
Under current law, homeowners over age 55 and persons with disabilities can use special rules to transfer current assessed value of a principal residence to a new principal residence. Such persons qualify for these special rules if their new principal residence is in the same county as the old principal residence and the value of the new principal residence is less than or equal to the value of their old principal residence.
Starting April 1, 2021, Prop 19 adds victims of wildfire or other natural disasters to the class of homeowners who are able to transfer their assessed value, regardless of age or disability status. Additionally, the new principal residence no longer needs to be in the same county as the old principal residence, but can be in any county in California. This benefit may now be used up to three times, up from one under the current law.
Transferring the assessed value can occur up to two years after the sale of the old principal residence and applies even if the value of the new principal residence is greater than the value of the old principal residence. However, any increase in value is added to the assessed value of the old principal residence.
For example, a homeowner is the victim of wildfire or other natural disaster and she sells her home for $3 million and she has a $1 million assessed value. If she buys a new principal residence in California for $3 million or less within two years, she can transfer her $1 million of assessed value to the new principal residence. But, if she buys a new principal residence for $5 million within two years, her assessed value in the new principal residence will be $3 million ($5 million - $3 million plus $1 million).
1 Generally, when all the parents of a grandchild are deceased, transfers from grandparents to grandchildren (Prop 193) may be exempt from reassessment. The Prop 19 changes for transfers from parents to children also apply to transfers from grandparents to grandchildren, and generally apply for transfers outright and in trust.
2 The $1 million limit is due to adjust every other year based on the House Price Index for California in the prior calendar year.