Election Day on November 3 was memorable in many ways, but with all the excitement since then, Californians may not remember all of the state ballot measures. There were a lot of propositions on the ballot, and many were confusing. So I wasn’t surprised when I received an email from my client Cedric asking for clarification about Proposition 19. As a property manager, Cedric asked me for details to share with his clients who are anxious about how their real property taxes will be impacted when Prop 19 goes into effect on February 15, 2021.
Should Cedric’s clients be anxious? Should you?
The short answer: it depends.
To refresh your memory, here is a summary of changes that were approved with the passage of Proposition 19—the ‘Property Tax Transfers, Exemptions, and Revenue for Wildfire Agencies and Counties Amendment’—which will go into effect next month:
- Eligible homeowners may now transfer their tax assessments anywhere within the state—even when moving to a more expensive home.
- The number of times that persons over 55 years old or with severe disabilities can transfer their tax assessments was increased from one time to three.
- Inherited properties that will not be used as principal residences, such as second homes or rentals, will now be reassessed at market value when transferred.
- Additional state tax revenue generated by the ballot measure will be allocated to wildfire agencies and counties.
Who benefits from the change?
If you are over 55 or have a severe disability and want to sell your home and buy another in California, Prop 19 offers important tax benefits—especially if you move more than once. Let’s say I want to ‘downsize’ from the home I own today to a beach cottage in Laguna Beach. In the past, I would only have been able to transfer my tax assessment to a home of equal or lesser market value, which would definitely rule out that little cottage in Laguna with a greater market value than my current home.
Under Prop 19, I will maintain the current property tax rate (even though the property has a higher market value), and I can move two more times without having to reset my Prop 13 basis. The new proposition allows moves anywhere within the state (prior rules limited tax basis retention to moves within a county or between select counties). There is a limit, however. If I move from an $800K property to a $1 million property, I will have to pay a higher assessment on the additional $200K of property value, paying the old amount on $800K and the new rate on $200K.
Other beneficiaries of Prop 19 are real estate agents (who, unsurprisingly, were the major backers of the measure); agencies and counties dealing with the impact of recent wildfires and protect against then in the future—including Orange County—; and schools (which, in my mind, are always a smart investment).
Who will be hurt by the change?
If you plan to pass on family property to your children or grandchildren—or if you anticipate inheriting property—Prop 19 eliminates the transfer of the existing property tax assessment unless the inherited home becomes the inheritor’s principal residence. So let’s say your grandmother bought a vacation home on Balboa Island back in 1960. Since then, every generation has enjoyed using the house as a getaway. Prior to Prop 19, if Grandma passed away and left you the property, you would also inherit her very low tax rate thanks to California Prop 13 that went into effect in 1978. Under Prop 13, the beach house provided more than just a great family gathering spot—it served as a great tool for building inter-generational wealth.
Under Prop 19, that all changes. Now, when you inherit a property, property taxes will be assessed on the fair market value of the home today unless you choose to live in the home as your primary residence. This change can be substantial since, in our example, Grandma was paying taxes based on the original $63,000 purchase price—and the property is now worth $3 million! Even if you choose to live in the inherited property, because the home’s fair market value is greater than $1 million, anything above the $1 million mark will be reassessed to the current tax values (using a complicated formula that blends the old Prop 13 basis rate with the portion of the home valued at over a million dollars). In other words, being a trust fund kid (or grandkid) just got a lot more expensive.
What can you do to avoid a tax re-assessment?
For families who want to preserve as much wealth as possible, there are a couple of strategies that can help:
- Strategy #1: The easiest option is to pass the property on to the heirs before February 15. Unfortunately, this requires someone actually passing on! Assuming nobody really wants to knock off Grandma(!!), let’s move on to some other more friendly options.
- Strategy #2: Live in the inherited home as your principal residence—at least for some time after taking ownership. While isn’t clear how long the home must be a principal residence to maintain the tax basis, it may be that you will be able to convert an inherited property to a vacation or rental after a set number of years while maintaining the existing Prop 13 rate. Only time will tell.
- Strategy #3: The most challenging option (but a wise one for some) is to sell or gift the property to the next generation before the February 15 deadline (which is really February 11 due to the Presidents’ Day holiday on the 15th). Note that placing your property in a trust will not bypass the tax impact of the change, so changing ownership before the deadline is the only surefire way to sidestep the tax hike for a property that will not become the primary residence of the heirs. (Watch out though: gifts of property don’t get a basis step-up, so you may find yourself trading property tax savings for capital gains taxes).
Whew! I’ve tried to explain Prop 19 as simply as possible (and admittedly oversimplified for the sake of clarity), but I know that’s a lot to digest. If you have any further questions, please ask—and please share this information with anyone you know who may be impacted by Prop 19. Many property owners are not aware of the change and how dramatically it may alter their property tax assessment. Knowledge is power! As always, I’m here to help!