17 Dec Prop 19: Understanding the changes to California property tax rules
An Interview by Ruth Krishnan on Prop 19 with Jennifer Jaynes, Estate Planning Attorney
Understanding Prop 19 and the recent changes
Ruth: I am with Jennifer Jaynes, trust and estate attorney extraordinaire. She’s going to talk to us a little bit about if we can sell a property keeping our tax basis as low as possible if we’re over 55 or disabled. How are you today, Jennifer?
Jennifer: Good, thank you for having me. It’s a pleasure to be here and to talk to you about the changes in the tax laws.
Ruth: Awesome, I’m so excited to have you. So Jennifer did my first trust and estate plan probably seven years ago and she has been amazing at helping us keep our trust and estate updated over the years, so thank you for all of your help with that. I do get calls from people who bought their house 20-25 years ago for $250,000 and now it’s worth $2 million. They don’t want to sell their house because they can’t afford to pay the property taxes on a new home. Can you talk a little bit about what was Prop 60 before, and what has been replaced by Prop 19?
Jennifer: All of this started with Prop 13, which is the main landmark proposition that amended the California constitution and dealt with real property taxes. There have been several propositions that have either expanded Prop 13, or stated that property taxes were going to be set at a certain value. As of 1976, that’s going to be your base year value, what the fair market value of the property was. Then from that point forward, its purchase price, if you purchase after 1978. It could only be increased annually, and it’s basically 1% of the value at that time, but could only be increased annually for inflation up to 2%.
That’s huge because property values in California over the last 40 years have increased substantially. If we’re going to limit the base value for property tax purposes from increasing more than 2% per year, some people that live in multi-million dollar homes now, that bought it for much less, obviously, are paying substantially lower property tax value. In a neighborhood you can have one neighbor that bought the house 30 years ago at $300,000 that pays $3,000 in property taxes each year, and then the neighbor who bought a property just recently for a million dollars is paying far higher in property taxes, approximately $10,000 per year.
That’s substantially different based on the property tax values. It was a huge benefit for those who purchased property at a much lower value to continue to pay property taxes at that rate. Now that properties have increased in value so much in California, it’s restricted some people from feeling that they can move to a new property, because they can’t purchase it at a much higher price and then also pay the increase in property taxes when they’re kind of locked in on such a lower rate that’s affordable to them.
That causes some problems for people who are elderly. People that are 55 years and older can move and transfer their property tax basis. In prop 60, people could transfer their property tax basis once to another location in the same county of equal or lesser value. That was huge because you could get rid of a larger home, a home with stairs, move closer to family, or whatever the reason why you wanted to sell your house. You would get to take your property tax basis with you.
Ruth: The new thing is that I can buy a more expensive house than I could buy before, correct?
Jennifer: Right, that’s also in any county in California. Previously they were limited to just 10 counties in California that were basically participating in this, which was difficult because many counties in the state of California didn’t participate. You couldn’t just transfer your tax basis anywhere. If they were hit with a natural disaster, and you weren’t in the county, you couldn’t move within the county and get a new property.
So it’s now anywhere in California, and they also increased the number of times that you can do it. So it was previously only one time where you could transfer your property tax basis, and now it’s up to three times. You can buy a lesser property, or a more expensive property. If you are moving to a location which may be in a more expensive area because your kids, family ,or friends are there, you can do that. You can transfer your property tax basis, but there is going to be an increase from what you are currently paying. You can’t buy a house that’s worth $2 million more and not pay a property tax on that difference in value, but you can transfer the basis that you have over.
Ruth: Got it. Well, I’m excited about that, because I think it’s going to mean more sales. I think there are some downsides to this for some families as well. Can you talk a little bit about what those are?
Jennifer: Prop 19 does have a lot of things that do benefit people, mostly people 55 and older, people that have chronic disability, and people who have suffered some sort of natural disaster. That’s the benefit, and we’ve talked about that.
The con of Prop 19 is that in order to pay for these types of transfers, they’re basically getting rid of something that a lot of families relied on, and that was the parent-child exclusion and parent-grandchild exclusion.
Another thing, people can’t inherit property now at the same property tax basis that their parents were paying, and that was a huge benefit for people in California. I don’t think any other states really have something similar, but this was the parent-child exclusion. Basically a child can inherit from their parents, who inherited from grandparents, who bought the house 40 years ago, and had a property tax basis at a very low number. Because it’s based on 1% of the value back then. It’s been just passed down from generation to generation, only increasing in value for inflation up to 2%.
That’s huge because going back to people in the same neighborhood paying very different levels of property tax, and the reason why I think that was enacted initially was that so children could move into their parents’ homes and not suffer what’s called a change in ownership, where the property gets reassessed and then they have to pay property taxes that they can’t afford.
Ruth: Let me make sure I get this clear. If I pass my house down to my children, not only would they have to pay the step up in property taxes when they sell, but they would actually have to pay it when they get it? Which means in some cases they can’t afford it and would need to sell it in order to pay the taxes. Is that right?
Jennifer: Sell immediately too because if the property tax was very low, and the property has increased in value substantially, the change in ownership happens as of date of death. It takes a while to prep the property for sale, and then go on the market. All of those months, even though it’s going to be sold, are going to be reassessed for property taxes at the new fair market value. That’s what changed with Prop 19 and not only did it get rid of that, you were allowed the chance for any amount of your primary residence. Your primary residence could be worth $6 million, $8 million, or $10 million. You could transfer that to your kids. Additionally, each parent could transfer a million dollars in assessed value.
It applied to commercial buildings, rental properties, investment properties, and vacation homes. Ultimately if you’re talking about assessed value, you could pass multiple properties, because the assessed values on those might be $200,000 each. So $200,000, five different investment properties that were going to the kids where they maintain the property tax basis. It’s huge, and the changes now that this is only going to apply to primary residence, and it’s a million dollars at fair market value. You get your assessed value plus the million dollars, and then everything else gets reassessed. If a property is worth $6 million, the kids are going to have substantially more to pay in property tax than they did before.
Ruth: Got it. I’m guessing there is something that people can do now before April 1st in order to help with all of this?
Jennifer: There are two different effective dates for the Prop 19.
1. 55 and older and moving your property tax basis, or taking your property tax basis with you, that’s effective April 1st.
2. The parent to child exclusion being removed is effective February 16th, 2021. The 15th of February is a holiday. So ultimately, we’re going to have to get it all done within the first couple of weeks of February and before because we need appraisals. There are clients who are calling and trying to make transfers to their children now.
Now you have to weigh a couple things, because if you gift property to your kids, while you might be retaining the parent to child exclusion for property taxes, you lose the step-up in basis that they would receive if they inherited the property upon your death, which can be huge if the basis in the property is low, and then the kids would have to pay substantial capital gains tax if they ever sold the property.
Everybody has a basis in most assets. Your basis and your home is your purchase price. That might increase or be adjusted for improvements, etc., but the basis is the purchase price. If your parents bought the property many, many years ago, and then they gift it to you during life, you take their basis, we call it a carry over basis. If they bought it at $200,000 and it’s now worth $2 million, we have substantial gain on that sale, if it sells at the $2 million, that would be taxed at long-term capital gains. If you inherit the property, then the kids inherit it at a step-up in basis on death. So then if they sell the property, they have no capital gains tax.
It really depends on every single family situation. It needs to be looked at closely as to what you’re going to do, and if you’re going to do anything before the February 16th deadline. A lot of families don’t have the ability to just gift real estate to their kids. Some families do have that ability. You’re going to be looking at their overall estate, their taxable estate, whether the kids even want to keep the property. The property tax value doesn’t matter. They don’t want to have it gifted at a lower basis, because they’re going to have the carry over basis, They’d rather just inherit it and sell it with no capital gains, because the property taxes won’t matter, they’re not going to continue to pay them.
You really do have to look at every particular situation. There are ways around it. I know a lot of estate planning attorneys are talking about not only lifetime gifts outright to their kids, but lifetime gifts into trusts for the benefit of their kids, taking advantage of some advanced estate planning tools, or potentially creating LLCs where you can transfer portions of the interest in the LLC to the kids. It’s kind of like a step transaction, but ultimately you transfer it and then you create an LLC, and as long as the ownership interest are the same as they were prior to transferring the property into the LLC, then it doesn’t get reassessed again.
There’s specific laws around that, and I just think if anybody’s considering, or is concerned about the potential negatives of Prop 19, being that the parent-child exclusion is basically going away, then I think they need to talk to their advisors.
Ruth: Got it. Okay, so is that everything on Prop 19 before we jump into a couple of questions about changes in presidency and potential tax things that might be coming up?
Jennifer: Sure, happy to talk about that.
Ruth: Okay. Yeah, just curious, I know there’s been a lot of talk about Biden making changes that’s going to affect taxes.
Is there anything that people can be thinking about with regard to their estate before changes take effect that could help them?
Jennifer: There is still a little bit of uncertainty. We do know that as of right now Biden’s won the election. If Republicans remain in control, some of these things may not be so eminent. He has proposed in his tax plan, a reduction in a state tax exemption amount. It’s currently at $11.48 Million per individual, which is relatively high. If you look back on what the estate tax exemptions have been over time, it is currently increasing every year for inflation. It will be $11.7 million in 2021, and it’s scheduled to revert back to what it was in 2012, set at $5 million increase for inflation in 2026. So as of January 1st, 2026, we already have kind of a reversion back to the $5 million increase for inflation.
Biden has proposed to reduce it to 3.5 million per person, potentially increase the estate tax rates, and also get rid of that step-up in basis that we were just talking about. A lot of things are still up in the air. I think it’s probably more likely that there will be a reduction in a state tax and potentially increase in the rate of a state tax. I think it will be a little bit more difficult to get rid of the step-up in basis, but nobody has a crystal ball, we’re all just waiting and seeing and doing the best we can with the information that we know. Now for my clients that do have taxable estates already, or are already close to taxable estates, we are talking about making gifts, and it can be gifts of any type of asset, to try and remove assets outside of the estate for estate tax purposes.
So there’s always ways, and your estate planning attorney can help you with that. There are advanced planning tools to gift assets out of your estate and maintain a little bit of control. Pass the assets to your children in what we call generation skipping trust, but basically allowing them to inherit assets that won’t be included in their estate for estate tax purposes. Because those generation skipping trust are sometimes referred to dynasty or legacy trust. We don’t want the assets that pass every generation to be subject to tax at every generation. So if parents pass their exemption amount, they can pass it to their children, and their children can use it. As long as they don’t take the money out of the trust, it will stay in trust, and then it can pass to their children without being taxed at their death.
There are some advanced tools, things to think about knowing the estate tax exemption amount. Do we want to make any lifetime gifts or any charitable planning? We don’t know exactly what’s going to happen, but I do think there will be time to make a lot of these lifetime gifts. While I thought that a lot of clients would be calling me for lifetimes gifts related to the exemption amount, I’m getting more calls on the Prop 19 changes, not only from people who want to take their assessed value with them, because they meet one of those three categories, but also from parents who want their children to inherit the property and keep it, and maintain the same property tax basis.
Ruth: Awesome. Thank you for taking the time to answer those. Do you have any other questions that you keep hearing over and over again from people?
Jennifer: Mostly it is about Prop 19 and what it is that they’re required to do. What are they taking with them? The one call that I got was from a potential client, who basically said, “Well, will I be taking my basis in property tax from when I first purchased the home, or the adjusted basis as increased for inflation?” Which I thought was relatively clear from the law, but ultimately you’re taking your adjusted basis, what it is as of today’s date, to the new property.
Then the other questions that a lot of people are asking with Prop 19 is, there is a requirement for the child to maintain the property tax basis, that million dollars and assess value in property tax basis. There’s a requirement that the child move into the primary residence, and make it their own primary residence, and what does that in fact mean? Unfortunately the BOE, the Board of Equalization, has not made all the rules public yet, they’re revising the assessor handbook. They weren’t the ones that proposed this law, so I don’t know if they’re really happy about the fact of how quickly they have to revise the assessor handbook.
We’re all still learning, but normally what primary residence means is that you’re taking a homeowner’s exemption on your property tax bill. So we check that little box and not everybody does it. So if you haven’t done it, make sure you check that box, even though it’s only $70 off your property tax bill, it is making an affirmative statement that this is your primary residence.
Ruth: Yeah, got it. So Jennifer, if anyone has anymore questions, what’s the best way for them to get in touch with you?
Jennifer: I’m happy to answer any questions that people have. My email is great, but where you can find all my contact information is on my website, which is just www.jenniferjaynes.com.
Ruth: Thank you so much for taking your time. I really appreciate it, and I learned a lot.
Jennifer: I’m happy to be here. Thank you so much, Ruth, for giving me the opportunity, and I look forward to talking to you soon.