In the past, California homeowners may have given little thought to transferring property to their heirs after death. But what about property taxes? In California, property taxes usually increase for the new owner, and could potentially represent significant cost.
California law previously provided generous exceptions for transferring real property to children while retaining the lower property tax basis enjoyed by the parents. However, Proposition 19, which passed in late 2020, significantly limits this parent-to-child exclusion.
So, before you sell a California property or transfer part of the ownership to a family member or trust, be aware of these new rules and what options are available to you in order to plan effectively.
Proposition 13, passed by California voters in 1978, was a groundbreaking law that has helped to keep property taxes under control for all California homeowners. However, it also caused some concern for individuals wanting to transfer that house to loved ones or put the property into an entity for liability protection or investment purposes.
Prop. 13 sets a property’s base-year value to what its price was in 1975 or when it last changed ownership. It then allows for annual property tax increases of no more than 2% until the property is sold or transferred. In most cases, the portion that’s transferred is reappraised to the full current market value at the time of this change. Given the rise in much of California real estate values, this has resulted in a substantial tax increase if the property appreciated since the time of the previous transfer or sale.
The state allowed for some exclusions to the change-in-ownership reappraisal rule. Below are the highlights of common scenarios and exclusions that helped to avoid unwanted property tax increases.
- Transfers between spouses and registered domestic partners (DP) is an automatic exclusion to an increase in the property tax base
- Through a trust (there are certain requirements to qualify)
- When one individual is being added to the title
- When one or more owners of the property dies (primary residence only)
- Upon divorce or termination of the partnership
For example, if you bought a home when you were single and later get married, you can add your spouse to the title without facing a property tax increase. Then, when one of you dies, that spouse’s half can transfer to the survivor without a reassessment. Another example would be if two individuals jointly own a commercial property 50/50 but want to transfer it to a limited liability company (LLC) for liability protection. No reassessment will occur if everyone retains their previous 50% ownership in the LLC.
Individuals could also qualify for an automatic exclusion from reassessment when changing the trustee of the trust holding the property or if transferring the property into or out of a revocable living trust.
Prop. 19 expanded previous rules allowing older homeowners to transfer their tax assessments when buying a replacement home. Effective April 1, 2021, homeowners aged 55 and older can move anywhere within California (rather than only to certain counties) and transfer their original Prop. 13 tax assessment value to a home of equal or lesser value, or to a more expensive home (but with an upward tax adjustment). Individuals can do this up to three times during their lifetime, whereas before, they could do so only once. Further, homeowners have two years for this exclusion if they are building a replacement residence.
In addition, Prop. 19 makes this exception available to people with severe disabilities or who are victims of natural disasters, such as the wildfires and floods many Californians have faced.
Transfers to children — However, Prop. 19 also eliminated most of the exemptions to transfer property to children that were previously afforded. Effective February 16, 2021, all property transfers to children will be reassessed, with one limited exception for the transfer of a primary residence to a child, as long as the child uses the home as their primary residence.
Though, if the home is worth more than $1 million, an upward tax adjustment will occur for only the value above $1 million. (Note: beginning February 16, 2023, and each year thereafter, the $1 million value will be adjusted for inflation to reflect the percentage change in the House Price Index for California as determined by the Federal Housing Finance Agency). For example, if a homeowner has a current property tax assessed value of $300,000 on a home valued at the time of sale at $1,000,000–and then purchases a new home for $1,500,000, the new assessed value is the original basis plus the purchase amount above $1mm, or $800,000.
Importantly, this reassessment rule will also apply to Qualified Personal Residence Trusts (QPRTs) that mature after the law takes effect. So, unless one of the trust beneficiaries takes possession of the home as their primary residence, the property will be reassessed for tax purposes at the time of transfer.
Legal entity exclusion — Transferring interest in a legal entity does not trigger a reassessment of real property except in certain situations. While there are many intricacies to the rules for this exclusion, generally reassessment occurs if a person or legal entity acquires more than 50% ownership in the entity or when more than 50% of the original owner’s interest are transferred (cumulatively). For example, if investment real estate is owned by a partnership held in the name of two brothers, and 30% of the partnership is transferred to a sister, the property tax basis would not change. If, however, the sister receives a 51% interest in the partnership, the property would be reassessed, possibly increasing the property tax liability. Therefore, this potential tax hike should be carefully considered when transferring ownership interests.
Actions to Consider
We urge clients to evaluate their estate and wealth transfer plans and decide on how or to whom they intend to transfer property in the future. Specific issues should be considered for the following instances:
- Changing the title of your home to a trust
- Changing the title of an investment real estate property to an entity for liability protection
- Taking advantage of the less than 50% exclusion for real estate property transfers
With these changes now in place, the complexity of the laws and legal options available make planning challenging, yet important, for many clients. Bordeaux’s advisors keep up on the latest tax legislation and we also recommend consulting your legal and tax advisors. Not proactively claiming reassessment exclusions, which you might be entitled to, can now cost tens of thousands of dollars.
Contact us to discuss your future goals and how Prop 19 impacts your decision for both real estate you own and your overall financial plan.
The material has been gathered from sources believed to be reliable, however BWA cannot guarantee the accuracy or completeness of such information, and certain information presented here may have been condensed or summarized from its original source. To determine which investments or planning strategies may be appropriate for you, consult your financial advisor or other industry professional prior to investing or implementing a planning strategy. This article is not intended to provide tax or legal advice, and nothing contained in these materials should be taken as such. To determine which tax planning strategies may be appropriate for you, consult your tax advisor. Investment Advisory services are offered through Bordeaux Wealth Advisors, LLC. Advisory services are only offered where Bordeaux and its representatives are properly licensed or exempt from licensure. No advice may be rendered unless a client agreement is in place.