The new year always brings new laws, but California’s passage of Proposition 19 has been at the top of our minds because of its potential impact on one of the most fundamental services we provide: helping parents leave their real estate to their children.
What was the law before Prop 19?
Prop 19 changes Prop 13, which is the current law regarding parent-to-child transfers of real estate in California. Important: Prop 13 expires on February 15, 2021, so any transfers after that date will be subject to the new law, Prop 19.
Under Prop 13, a property owner could leave their primary residence, plus up to $1 million in assessed value of other real estate, to their children (and qualifying grandchildren) and the assessed value would transfer with the property. This meant that real estate purchased years (or decades) ago could continue to have the same property taxes even after the property was transferred to the owner’s children, and then to the children’s children, etc. So Prop 13 was a powerful tool for multi-generational planning.
Additionally, owners over 55 years old, owners with severe disabilities, or owners who have lost a home in a natural disaster, could transfer their property tax basis one time to a new home within certain counties as long as the home was of equal or lesser value.
What does Prop 19 change?
First, Prop 19 changes the unlimited exemption for the primary residence to a $1 million exemption. So, depending on the value of your primary residence (keeping in mind appreciation of your primary residence between now and the date of death), this change may or may not affect you. For primary residences worth over $1 million (or projected to be worth over $1 million at the date of death), you can expect some increase (which could be substantial depending on the value of the residence) in property taxes when that property passes to your children.
Second, Prop 19 adds a requirement that, in order to qualify for the exemption, a child receiving property must use that property as its primary residence. How is this going to be treated when multiple children inherit property but only one child uses it as their primary residence? At this point: who knows? Prop 19 itself is silent on this, but we expect supporting regulations to be released to clarify.
Third, Prop 19 eliminates the exemption for other property. So second properties, investment properties, etc., simply won’t qualify for the parent-child property tax exemption.
Finally (and this is a good thing), Prop 19 expands the exemption for owners over 55 years old, owners with severe disabilities, or owners who have lost a home in a natural disaster. These groups of people can now transfer their tax assessment up to three times (versus once under Prop 13) and they can do so statewide (instead of within certain counties under Prop 13). So for these groups of people, Prop 19 is potentially beneficial.
How do these changes affect you?
If your primary residence is worth less than $1 million, and its value doesn’t increase above $1 million by the date of death, AND your child chooses to use the property as its primary residence, then you should not be impacted by Prop 19.
If your primary residence is worth more than $1 million, and even if your child chooses to use the property as its primary residence, then your child will likely have to pay additional property taxes (may be substantially more, depending on the value of the property) under Prop 19.
Under either scenario above, if your child does not choose to use your primary residence as their primary residence, then no exemption will apply and the property will be fully reassessed at fair market value.
Also, if you planned to leave other property (non-primary residence real estate) to your children, then you will definitely be impacted by Prop 19: the exemption for other property is simply gone. The sliver of silver lining is that property tax treatment of business entities (e.g. LLCs) was not changed by Prop 19, so you may have a workaround that bypasses Prop 19 entirely. We regularly place real estate in LLCs, for various reasons, and Prop 19 is yet another reason to think about doing so.
What can you do now?
The tiny bit of good news is that you have options, but you have to move quickly. Gifts to your children (outright or through a properly drafted irrevocable trust) can be done now, but they must be completed before February 16, 2021. That’s not a lot of time by any means, and certainly not when we’re making major decisions about your assets and your family.
But you also need to watch out for unintended consequences: gifting your property now could create other tax issues unrelated to property taxes, undermine your overall estate planning objectives, or expose your property to the liabilities of your children.
What should you do now?
Contact your professional advisors (legal and tax) immediately. Our firm has been flooded by inquiries from existing and new clients concerned about Prop 19. Don’t let time make the decision for you – contact us today.