Effective February 16, 2021, State Proposition 19 alters how transfers of parent to children and grandparents to children are treated for reassessment.
Essentially, the proposition eliminates the parent-child and grandparent-grandchild exclusion from reassessment for properties other than still allowing that exclusion for “family home.”
Prior to the new law, a parent could transfer the parent’s primary residence and up to $1,000,000 of assessed value other property such as commercial property, rental properties, second homes, investment properties to their children and such properties would retain the low adjusted base year value for property tax purposes. In the hot California real estate market, this could save tens of thousands of dollars in property taxes for the children or grandchildren receiving the property.
This mean that if my grandfather only paid two hundred thousand for investment property that he now gives me, that I will pay property taxes on the two hundred-thousand-dollar value, even if is now appreciated to two million dollars.
But under the new law, unless both the parent and the child will use the property as his or her primary residence, the exclusion is terminated. Thus, children or grandchildren inheriting property from their parents or grandparents, unless it is the primary residence, may see a substantial increase in property taxes on such inherited property. And there are other changes, mostly adverse, but with some benefits.
The new law reduces the parent-child exclusion on a primary residence or “family home” from unlimited value to one million dollars above the current assessed value. As such, even if a parent transfers his or her primary residence to their child who also uses it as a primary residence, there could still be an increase depending on the assessed value of the property. In the Bay Area, such reassessment will be likely, given our appreciated property.
The new law requires the “family home” to qualify as both the primary residence of the transferor (i.e., parent) and the transferee (i.e. child). The law is thus restricted to a primary residence going to a child or grandchild as his or her primary residence.
For those above fifty-five years of age, or with a disability, there is a benefit in the new law. In most instances, a California homeowner over age 55 or with severe disabilities will have the ability to transfer their current property tax assessed value of their primary residence to another primary residence anywhere within California. This eliminated the distinction amongst counties on which would approve a base year value transfer. This change also allows individuals to purchase a more expensive property rather than just a less expensive property and keep the benefits of the base year value transfer.
If a more expensive primary residence is purchased, there is now a formula to minimize the increase in base year value. The new law also increased the number of times this exception can be used from one to three times.
The Board of Equalization, which governs how property taxes are applied, issues guidelines and updated forms to match the Proposition that just passed and will be fleshing out the details of how this law will be applied.
Issues With Estate Planning:
If a parent was planning to give a property to a child at their passing in their trust or in other estate planning documents, they would lose the benefit that would apply if the transfer was made before February 16, 2021, if preserving the base year value property tax is important. But note that a gift during lifetime will not receive a step-up in basis on the death of the parent but would receive such step-up in basis only if held by the parent until their passing. The loss of stepped-up basis may result in greater tax cost than the saving of property taxes and a good accountant should be consulted.
Also note the transfer of property from parent to child that is subject to a mortgage may trigger the Due on Sale clause, causing the bank to have the right to require payment in full of the mortgage. The gifting parent or grandparent also loses the income from the property and must eliminate the equity of such property from their net worth. Parents will also be required to prepare and file a gift tax return.
In terms of using an LLC for asset protection, the old fear of losing the benefit of the lower property taxes is no longer applicable after February 16, 2021 since it is not available in most cases in any event. Thus, the creation and utilization of an LLC may be a better option for asset protection purposes.
As with all tax and estate planning, one must integrate into the plan family dynamics and likely needs of the elder generation in the future. As one client put it, “Saving taxes is well and good, but not at the cost of making me have to ask my grandkids for help in a decade or so.” Taxes are but one aspect of a good estate and tax plan and while avoiding property taxes can result in significant tax savings, that should not blind a family into considering all the needs of all the members of the family, taxes or not.