Prop 19, which barely passed with 51 percent of the vote by emphasizing the aspect of the law allowing for property tax base “portability” (allowing homeowners to transfer their Proposition 13 base-year value anywhere in California) also brought with it a considerable downside as it relates to estate planning with California real estate.
The Law Before Prop 19 Broadly Supported the Parent-Child Exclusion from Reassessment
Under "pre-Prop 19" law, which is valid through February 15, 2021, when a parent transfers their principal residence to a child, it is excluded from property tax reassessment, meaning the child takes the same property tax base as his or her parent had under Prop 13. This "parent-child exclusion" applies regardless of the market value of the property at the time of transfer, and regardless of whether the child uses the property as a principal residence or for some other purpose, such as rental or vacation property. In addition, the first $1 million of assessed value (which is usually less than market value) of any "other property" such as rental, business, or vacation property, is also excluded from reassessment when transferred between parent and child, provided the exemption is timely claimed.
This "parent-child exclusion" has been a powerful estate planning tool for decades, due to the ability of a parent to pass along family property to their children without concern that its tax base would be reassessed to fair market value at the time of the transfer.
How Prop 19 Narrowed the Parent-Child Exclusion Considerably
Prop 19 has significantly narrowed the parent-child exclusion. From February 16, 2021 onward, the only property that can be excluded from property tax reassessment when transferred between parents and children is property that qualifies as a personal residence of both the parent and child. In other words, it must qualify as the parent's principal residence at the time of transfer, and the property must qualify as the child's principal residence after the transfer. Certain farm property may also qualify for the exclusion. That means that other transfers of rental, business, or vacation properties will no longer qualify for the parent-child exclusion and will therefore be reassessed upon transfer of ownership. But it doesn't stop there. Even if the property qualifies as a principal residence, the fair market value of the residence at the time of transfer cannot exceed the transferor's taxable value by more than $1 million. To the extent that the fair market value of the principal residence exceeds the transferor's taxable by more than $1 million, the the property is going to be reassessed.
These changes will significantly increase the cost to children who retain family property they inherit, because the property taxes will likely be much higher than they were during the parent's lifetime. In many cases, this will result in properties being sold that may have otherwise been kept as family legacy property. According the the Daily Breeze, the prospect of increased real estate sales was a large motivator behind the marketing dollars spent on Prop 19. According to this article, the California Association of Realtors spent $50 million on ads claiming Prop 19 was beneficial to taxpayers, while omitting the sneaky, billion-dollar property tax increase that will result.
Estate Planning Strategy in Light of Prop 19: Consider Making Transfers of California Real Estate by February 15, 2021
If you you want to avoid property tax reassessment, it will be necessary to transfer California real estate that you plan to leave to your children (or grandchildren if their parent is predeceased) by February 15, 2021, before Prop 19 kicks in. These gifts can be made of the entire property, either outright in an intentionally defective grantor trust, of a partial interest as co-tenants, or as part of an entity such as an LLC. Be sure to work with experienced counsel in making such transfers in order to ensure that the parent-child exemption is properly claimed, and that you are taking the best approach if a partial interest is going to be transferred through co-tenancy, or as a partial interest in an LLC or other entity to help lay the foundation for the optimal tax outcome down the line when the parent(s) pass. You may also want to review this article on our blog, which I posted right around election time, discussing estate and gift tax reasons to consider making gifts (of any kind of asset or property) now as opposed to at death.