Estate Planning in Light of Tax Changes in California
as a Result of Proposition 19
By: Lauren Jones
California voters approved Proposition 19 in November 2020, which amended the California constitution. The proposition affects people who own real estate, especially rental/investment real estate, who want to one day pass these properties to their children. While it was not a popular decision and passed by a narrow margin, it is not fatal to you passing property to your children. However, it should be a consideration when doing estate planning.
First, Prop. 19 limits the ability of a parent to pass their Prop. 13 property tax basis to their children in their personal residence at death. These exclusions will now only apply if the transferred property was the transferor’s primary residence, and the recipient also uses the property as his or her primary residence. Therefore, it is no longer possible for a child to keep the parents’ residence as a second home or rental property without being subject to a property tax reassessment. Further, the differential between the property tax assessed value and the current market value of the residence must be less than $1 million. Otherwise, only the first $1 million in differential is not subject to reassessment.
In addition, under this new law, all investment/rental properties transferred will be reassessed upon transfer for calculating the annual property taxes. Therefore, it is no longer be possible to transfer second homes or investment/rental real estate to your children without a property tax increase.
How does this affect your estate planning?
1) Think twice about requiring that a property stay within the family instead of being sold.
While it is nice to have a family home pass through the generations, giving your children the option to keep or sell the property lets them to decide at the time of your death what works best for them and their circumstances. A child may be able to move into the family home and avoid the re-assessment. Your children may choose to keep it as a rental and pass the increased tax reassessment onto the tenant. However, your children may need to sell the property. Transferring the asset upon your death while giving them flexibility to keep or sell as needed will let them decide how they handle the effects of Proposition 19.
2) Reconsider adding your children to your deed or transfer your property to them when you are alive.
Transferring your property while you are alive by adding your children to your deed our fully gifting, will likely lose the stepped-up basis at death.
What is the stepped-up basis? When an individual dies, their heirs receive a “stepped up” cost basis on all the inherited assets. This means that any capital gain which has occurred prior to an individual’s death is wiped out upon death and the cost basis for the beneficiary is reset based on the date of death value. Therefore, if a beneficiary wants to sell an inherited asset, the capital gains tax is based on the difference between the value of the asset when it was inherited and what the asset is sold for.
In light of Proposition 19, there are additional tax consequences that can be felt now. If your children are are not living in the property as their primary residence, there will be a property tax reassessment.
Transferring property now, even by adding your children to your deed, will loose on significant tax savings.
If you would like to discuss your estate planning in light of Proposition 19 feel free to contact us to set up a consultation. We look forward hearing from you soon!