Navigating New California Proposition 19: Its Dramatic Property Tax Increase on Inherited Property

  • August 16, 2021
  • devinlucas

Article below; video below….

Lucas Real Estate – Attorney Devin Lucas and CPA Courtney Lucas – are experts in California intra family transfers using all aspects of Propositions 13, 58, 193, 60, 90 and new Proposition 19. Learn more about how Lucas Real Estate may help your family transfer by clicking here.

Questions? – Paid one-hour confidential legal consultations are conducted daily via Zoom and address virtually all questions, options, tax implications and strategies. (Book a consultation here.)

Editorial Summary

California Proposition 19 is a massive property tax hike on the next generation of property owners.  It wiped out the former Proposition 58 and Proposition 193 family transfer benefits, as of February 16, 2021. 

You can no longer transfer your Prop 13 basis to your children, except under limited situations, see below. This is potentially the largest property tax increase in California history… but it will only impact the next generations; this is a new death tax and inheritance tax on real property owners’ heirs.  

Note – there are some newly expanded transfer benefits for those 55 and older and victims of natural disasters that will be addressed in a subsequent article.

Read on to learn more and/or watch our recent presentation here:

HOW DOES PROPOSITION 19 WORK AS TO FAMILY TRANSFERS, INTRA-FAMILY SALES AND INHERITED PROPERTY?

As of February 16, 2021, if you transfer your property to your children (or, grandchildren, if the parents are deceased), via any means (gift, sale, hybrid, estate plan after your passing, etc.) that property will be reassessed to full market value for annual property tax purposes. 

Due to Proposition 19, your children will no longer inherit your Proposition 13 value, or, “prop 13 basis” as had been California law for nearly 25 years (under former Proposition 58 and Proposition 193).

Only one limited exception will apply (detailed below), but all investment properties, even if the child plans to live in it, will be reassessed to full value upon transfer.  

This revokes the long-standing tax benefits of Proposition 58 and Proposition 193 (detailed article on the enormous benefits of Proposition 58 and Proposition 193 here), overwhelmingly passed in November 1986 and March 1996, respectively, which allowed parents to transfer their property tax basis of a primary residence (regardless of value) to their children and up to $1mm of assessed value of all other property ($1mm of the prop 13 value on rental properties or other investment properties passed to heirs, not based on fair market value, effectively allowing far more than $1mm of property value to transfer while retaining the low bill).  These propositions – Proposition 13, Proposition 58 and Proposition 193 – saved children thousands upon thousands of dollars per year.  (read here to understand dramatic savings of [now gutted] Proposition 58 and Proposition 193.)

No more.  Special interests have uprooted this hallmark financial protection for California homeowners and passed a new death tax and inheritance tax on real property owners via Proposition 19.  As of February 16, 2021, full reassessments will occur on all family transfers, with limited exceptions detailed below.  

If a death or notarization occurred prior to February 16, 2021, you may be able to take advantage of the ‘old’ proposition 58 and proposition 193. Otherwise, as of now, all new family transactions (including sales, gifts and death) will be subject to Proposition 19.

Areas with the highest property values, such as Newport Beach, Laguna Beach, Coastal Orange County, San Francisco Bay Area, etc., will be impacted the most by Proposition 19; overall, per the Legislative Analyst’s Office, California’s next generation of property owners will be taxed to the tune of hundreds of millions of dollars per year as an anticipated impact of California Proposition 19.  Groups such as the Howard Jarvis Taxpayers Association would argue that figure is more likely in the Billions, with a “B”.

ONE LIMITED EXCEPTION – “FAMILY HOME” WORTH UNDER $1MM AND A BLENDED RATE IF WORTH OVER $1MM

One limited exception to full reassessment exists: the transfer of a “family home” (meaning a home the parents currently live in), to a child, where the child will live in the “family home” within one year of transfer, but only if the home’s fair market value at the time of transfer is less than one million dollars ($1,000,000).  If the home’s fair market value at the time of transfer is greater than one million dollars ($1,000,000), then a complicated formula takes over to blend the old prop 13 basis rate with the portion of the home over one million dollars ($1,000,000).  

This will result in some benefit for many (vs. a full reassessment), but is still a dramatic tax on inherited real property.  $1mm is a pretty low threshold for California real estate, especially in Newport Beach and other coastal areas, and by no means indicates the owners are “rich.”  Indeed, many families purchased homes decades ago for modest sums, only to see their sound investments increase in value, but that does not mean they can afford to pay taxes based on those higher values.  That was the whole point of California’s landmark Proposition 13, and its later offspring with Proposition 58 and Proposition 193.

If the home was not the primary residence of the parents, a full reassessment will occur, even if the child plans to live in that home. 

If the home was an investment property, or a rental, a full reassessment will occur, even if the child plans to live in that home. 

NOTE – Uncertainty exists surrounding many aspects of Proposition 19’s implementation. The state is issuing updated guidance, counties are working on their own interpretations, and eventually challenges and lawsuits are likely to further define Proposition 19 for the years to come. You should consult with legal counsel and contact your county’s Assessor to discuss specific impacts to your home.

WHAT CAN YOU DO / HOW TO PLAN AND STRATEGIZE FOR PROPOSITION 19 AND PRESERVE YOUR PROPOSITION 13 BASIS FOR YOUR CHILDREN?

Unfortunately, given Proposition 19 is now in effect, all new transfers (via sale, gift or death) are subject to Proposition 19.

You should consult your California state representative to express your concerns (click here to find your local elected officials). There are groups, such as the Howard Jarvis Taxpayer’s Association seeking to ‘reinstate 58’ and bring back the prior laws and benefits. We urge you to contact your representatives and/or join the Howard Jarvis Taxpayer’s Association if you are interested in bringing back the old benefits.

Prior to Proposition 19’s implementation, we had suggested families strongly consider an outright transfer of the property (via sale, gift or a hybrid of the two) before February 15, 2021. A typical Trust will NOT work to avoid the reassessment (see below). However, since this deadline is passed, you are now subject to Prop 19 rules.

You can still gift your property to your children, sell your property to your children, or a hybrid of the two, but will have to qualify under Prop 19 or face a reassessment. (Our earlier article, linked here, explains the various options for such a gift or sale, and the enormous benefits of Proposition 58 and Proposition 193 that will lapse on February 16, 2021.)

DOES MY WILL OR TRUST WORK TO CIRCUMVENT OR BYPASS PROP 19 AND PASS BY PROP 13 BASIS TO MY CHILDREN?

NO. A typical will or a typical trust will NOT work to bypass Proposition 19. Trusts are essential estate planning devices and work to avoid probate (i.e. a court process after your death), but it will NOT change the law as to Prop 19. When you pass away, that is the trigger for the property transfer. If you pass away on or after February 16, 2021, your property will be fully reassessed, even if held in a Trust.

However, there are “irrevocable trusts” that actually change the beneficial ownership at the time of creation and MIGHT be a workaround. Some attorneys were drafting these prior to Prop 19’s implementation and time will determine their effectiveness.

WHAT ABOUT AN LLC OR FAMILY LIMITED PARTNERSHIP OR ANY OTHER CREATIVE WORKAROUND AS A STRATEGY TO AVOID A PROP 19 REASSESSMENT?

LLCs and Family Limited Partnership have been around for a long time and are often used by high-net-worth individuals and families for tax, estate planning and liability protection purposes. Entities have always had different rules than family transfers, and those rules will remain in place regardless of Proposition 19.

While LLCs and Family Limited Partnership can be used to avoid reassessments when fractional interests are transferred, they must be created precisely right to achieve the desired goal and simply do not work for all families. When too much ownership or control is transferred (generally over 50 percent), a full reassessment of the property will occur.

Moreover, there’s annual tax , maintenance and creation costs for such entities. The entity rules are beyond this article but can be used by some families to hold real estate and avoid reassessments.

WHAT ABOUT JOINT TENANCY AS A STRATEGY TO AVOID REASSESSMENT DUE TO PROP 19?

Holding title in “joint tenancy” (or as “joint tenants”) can be used under the right set of circumstances to avoid property tax reassessment, at the time of the transfer, but will still result in a reassessment at the death of the original owner(s).

Joint tenancy has always been used to help avoid probate for those that do not want the formalities, complexities or expense of a trust. But it is not the right vehicle for most people and will still be subject to Prop 19 upon death or transfer.

[NOW MOOT DISCUSSION] WHY NOT TRANSFER PRIOR TO PROP 19 IMPLEMENTATION? / CONSIDERATIONS FOR ANY FAMILY TRANSFER

FOREMOST, since Prop 19 is now in effect, this is moot as to avoiding Prop 19, but still considerations to address if thinking of a transfer. For illustrative purposes, people still considering a transfer now, and people with regret for missing the deadline, review these considerations which indeed caused many families to not transfer, even under the prior laws…

The Step-Up In Basis, aka stepped up basis, aka step up basis.  This favorable tax law currently provides better tax benefits to your heirs at death, vs. during life, by dramatically reducing the capital gains on a sale of real estate post death.  (again, detailed here in our prior article).  However, President-elect Joe Biden proposes elimination of this tax benefit (citations below). Planning on the future of tax laws is always difficult. We know these property tax increases will occur on transfers after February 15, 2021; we do not know what the future holds for the step up in basis.  If the step-up in basis is eliminated, and the transfer occurs after February 15, 2021, that could be an upsetting double tax increase to the heirs. 

An existing loan on the property.  This must be addressed, as an outright transfer would likely violate the “due on sale clause” of the current loan.  Often, the child can “purchase” the home (for any value, fair market or not), obtain a new loan to pay off the old loan, and potentially even use additional equity in the home for the parent’s or children’s benefit. 

Simply not ready to give away assets until death.  This is, of course, a personal decision.  Future tax laws may become more favorable, or less, overtime.  Many make estate planning decisions around these laws; many do not care.  

WILL THIS BE REVERSED OR CHANGED IN THE FUTURE?

This was a constitutional amendment by ballot proposition. It will likely take a new ballot proposition to “undo” or change Prop 19 (i.e. to reinstate the benefits of Prop 58 and Prop 193).

Impacted voters should contact their elected representatives to discuss their view (lookup your representative here: findyourrep.legislature.ca.gov) and consider membership or donations to organizations such as the Howard Jarvis Taxpayers Association that advocate for property owners and are seeking to reinstate the former Prop 58 and 193.

CONCLUSION

Again, this new property tax increase of Proposition 19 cannot be understated.  Family transfers (via sale, gift or death) as of February 15, 2021 on all rental properties, all investment properties, and any properties not used as the parents’ primary residence, will result in reassessments to full market value, potentially resulting in thousands upon thousands of dollars in new annual property taxes to the next generation of owners, even if the children plan to live there.  Family transfers starting February 15, 2021 on family homes where the parents reside at transfer, and the children will live within one year of transfer, worth over $1mm in today’s value, will result in a partial reassessments, potentially resulting in thousands upon thousands of dollars in new annual property taxes to the next generation of owners.  

Note – there are some newly expanded transfer “benefits” within Proposition 19 for those 55 and older and victims of natural disasters that will be addressed in a subsequent article (essentially expanding proposition 60 and proposition 90 benefits to allow up to three transfers, anywhere in the state, and regardless of value of the replacement property, i.e. allowing a blended property rate to purchase a more expensive replacement home).  This article addresses the family transfer portion of Prop 19.   

Property owners should have a frank analysis today about their estate planning and if a transfer, sale, or gift is right for them at this time.  Consult appropriate professionals familiar with these existing and new laws.   

– Devin Lucas

Author Devin R. Lucas is a Real Estate Attorney, Broker and REALTOR®, specializing in Newport Beach, Costa Mesa and Orange County coastal communities, serving individual and investors in residential real estate.

Lucas Real Estate – Attorney Devin Lucas and CPA Courtney Lucas – are experts in California intra family transfers using all aspects of Propositions 13, 58, 193, 60, 90 and new Proposition 19. Learn more about how Lucas Real Estate may help your family transfer by clicking here.

Questions? – Paid one-hour confidential legal consultations are conducted daily via Zoom and address virtually all questions, options, tax implications and strategies. (Book a consultation here.)

Lucas Real Estate
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SOURCES:

Official California Proposition 19 Voter Guide:

https://voterguide.sos.ca.gov/propositions/19/

Official California Proposition 19 Voter Guide – Legislative Analyst’s info: 

https://vig.cdn.sos.ca.gov/2020/general/pdf/prop19-title-summ-analysis.pdf

Official California Proposition 19 Text of Proposed Laws:

https://vig.cdn.sos.ca.gov/2020/general/pdf/topl-prop19.pdf

California Constitution, Article XIII:

https://leginfo.legislature.ca.gov/faces/codes_displayText.xhtml?lawCode=CONS&division=&title=&part=&chapter=&article=XIII

Details of President-elect Joe Biden’s proposal to eliminate the Step-Up In Basis, aka stepped up basis, aka step up basis:

https://taxfoundation.org/joe-biden-tax-plan-2020/#Details

https://www.politifact.com/factchecks/2020/oct/29/facebook-posts/yes-biden-seeks-eliminate-policy-reduces-inheritan/

https://www.forbes.com/advisor/retirement/biden-tax-policy-step-up-in-basis/

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