On November 3, 2020, California voted in favor of Proposition 19. Passing this proposition provides a property tax break for older homeowners and raises taxes for those inheriting family properties.
Proposition 58: The Proposition Prior to Proposition 19
Proposition 58 is currently in effect. It allows parents to transfer a primary residence to their children without any new fair-market reassessment. This applies regardless of how the children chose to use the real property. This allows children to inherit the same property tax basis their parents. They can transfer the primary residence with no cap on the assessed value. Before Proposition 19, secondary properties could transfer with up to $1 million exempt from tax increases.
The Difference Between Tax Assessment and Fair Market Assessment
A tax assessment is the value assigned to real property by the local government to collect taxes that support the community. A fair market assessment is the value of real property based on its potential sale price on the open market.
Who is Prop Proposition 58 Most Favorable To?
Proposition 58 is most favorable to families that have owned real property with low assessed values. For instance, a 60-unit apartment complex in the San Francisco Bay Area purchased by a married couple in 1979 may have an assessed value just under $2 million. Under Proposition 58, the couple could transfer this property to their children without reassessment.
When Will Proposition 19 Become Effective?
Proposition 19 replaces Proposition 58. Beginning February 16th, 2021 the ability to transfer $1 million of assessed value of other property that is not the primary residence is completely eliminated.
Two Conditions Must Be Meet Under Proposition 19
The ability to transfer a primary residence between parent and child without reassessment will not apply unless two conditions are made. The two conditions are: 1) the parents’ primary residence must also become the child’s primary residence, and 2) the fair market value of the primary residence at the time of transfer cannot exceed the parents’ assessed value by more than $1 million. If, at the time of transfer, the difference between the assessed value and the fair market value of the home is more than $1 million, the new assessed value will be the fair market value less $1 million.
For example, if parents purchased a rental property in 1940 for $50,000, and the value of the rental property is more than $1 million when it is transferred to a child after February 16, 2021, the parents’ tax basis does not pass to that child. Therefore, the child will now have to pay the property tax based on the assessed fair market value.
Examples of How Prop 19 Works
Example of how Prop 19 works: a parent owns a home that is his primary residence and has a rental property in California. The home has an assessed value of $500,000 and a fair market value of $3 million. The rental property also has an assessed value of $500,000 and a fair market value of $2 million. Even though the properties have different fair market values, their property tax liability is similar because they have the same assessed value. The combined annual property tax of both properties with a property tax rate of 1.25% is $12,500. The parent now wishes to transfer both the properties to his daughter.
Result Before Prop 19
Before Prop 19: No reassessment on the home or rental property transfer. The parent can transfer the home regardless of value, and the rental property’s value is below the $1M threshold. Thus, the combined annual property tax will remain at $12,500. The daughter can use both properties as investment properties without restrictions.
Result With Prop 19 in Effect
Result with Prop. 19 in Effect: there is an adjustment to the assessed value of the home and a full reassessment on the rental property. The new value is $2 million, as the fair market value exceeds the previous by over $1 million. The rental property’s new assessed value is $2 million, as no exemption applies to non-primary residences.
Thus, the new combined annual property tax will be $50,000. If the daughter doesn’t live in the family home, it will be reassessed at $3 million, raising the annual tax to $62,500.
The Impact of Proposition 19 on Real Estate Inheritance and Taxation
Proposition 19 significantly changes the tax rules for inheriting real estate. Prior to its enactment, parents could pass homes or second homes to their children under Proposition 58. They could change them without changing the tax assessment as long as the value of the property did not exceed a prescribed threshold.
How Proposition 19 Changes Taxation
After the passage of Proposition 19, the situation changed. Now, when property is transferred, the tax basis is recalculated if the value exceeds $1 million. This means that heirs who receive property from their parents must pay taxes based on the fair market value of the property. For example, if the value of a home exceeds $1 million, the new estate tax could increase significantly.
What Heirs Need to Consider
An important point for heirs to consider is that if the property received is not the principal residence, it will be subject to a full revaluation. This will result in a significant increase in tax liability. However, if the heirs continue to live in the house transferred to them, they can keep the tax relief. But only if the difference between the market value and the assessed value does not exceed $1 million. For more information on Proposition 19 and its effect on tax liability, contact KAASS LAW.
Los Angeles Real Estate Attorney
For more information on Proposition 19 we invite you to contact Our Los Angeles real estate attorney at (310) 943-1171.