The November 3, 2020 election is anticipated to have far reaching impact on many issues. One such issue on the California ballot relates to Proposition 19's effect on real property taxes. Proposition 19 was recently added to the ballot in June. If passed, it can result in an increase in property taxes for transfers of California real property between parents and children. Now is the window of opportunity for families to review and plan for possible transfers of real estate to their children.
Under current law, a transfer of ownership in California real property generally results in a reassessment for property tax purposes. Such reassessment typically means an increase in real property taxes. There are currently two exclusions from reassessment that can apply for transfers between parents and children:
- Principal residence exclusion- this permits the transfer of a principal residence of unlimited value between parents and children without being subject to reassessment; and
- The $1 million lifetime non-principal residence exclusion- this permits the transfer between parents and children of up to $1 million of assessed value of all other types of property (e.g., second homes, rental properties, commercial properties) without triggering a reassessment. The $1 million exclusion is based on the current assessed value, which can often be lower than the current fair market value, thereby allowing the transfer of a higher percentage of the property without reassessment. For a married couple, this would be a combined $2 million lifetime exclusion.
Proposition 19, if passed by voters, would significantly alter the parent-child exclusions as follows:
- In order to qualify for the principal residence exclusion, it would require the receiving child to use the residence as the child's own principal residence, and the exclusion amount would not be unlimited. Instead, it would only exclude the first $1 million of assessed value; and
- The non-principal residence exclusion would be eliminated entirely.
In addition to these modifications to the parent-child exclusions, Proposition 19 also makes other changes that can be favorable for persons over 55 who wish to transfer the property tax value of their principal residence upon sale to their new replacement residence. The increased tax revenue resulting from the modifications to the parent-child exclusions will be dedicated to fund local firefighting efforts, as well as offset the decrease in tax revenue from the over 55 transfers. Because fighting wildfires has risen to prominence in recent years and since the changes to the over 55 transfers may be viewed as favorable to the taxpayers, they can help promote the passage of Proposition 19 by the voters.
If Proposition 19 is approved by the voters, the changes will be effective on February 16, 2021 (for the parent-child exclusions), and April 1, 2021 (for the base year value transfer by persons over 55).
Consider transfer of real estate to children in 2020
Because of Proposition 13, the increase of a property's assessed value for property tax purposes has been limited to 2% each year, absent a change in ownership. Therefore, families that have been holding real estate for a long period of time likely enjoy relatively low real property tax assessed values. Currently, the parent-child exclusions permit a generational transfer of highly-appreciated property while maintaining annual property taxes at a relatively low rates for as long as the child owns the property. Since Proposition 19 would severely limit the principal residence exclusion and eliminate the non-principal residence exclusion entirely, families may wish to consider prioritizing plans to transfer real properties to children now while the current rules are in effect, with specific emphasis on highly-appreciated properties since they leverage the combined benefits of Proposition 13 and parent-child exclusions with maximum effect.
In addition, the federal gift tax exemption is currently at the historic high of $11,580,000 in 2020. There are speculations that such exemption can be reduced depending on the results of the Congressional and Presidential election this November.
There are a number of planning strategies to consider in making the current transfer, including using trusts, limited partnerships and limited liability companies. Planning is also possible for future transfers of property should Proposition 19 be passed by the voters. For example, if you plan to obtain property in the near term and wish to transfer such property to your children in the future, you may consider purchasing and holding such property in a legal entity. Depending on the circumstances, this type of planning may allow for the transfer of portions of such legal entity to your children without triggering a reassessment under current legal entity exclusions, irrespective of the parent-child exclusions. Furthermore, the transfer of partial interests in the legal entity could likely result in valuation discounts in determining the fair market value of the transfer for estate and gift tax purposes.
These are some examples of planning issues and options to consider, and there are others. Each situation is unique and Withers experienced estate planning and real estate counsel would be pleased to advise on the planning opportunities.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.