Effective February 16, 2021, most parent-child gifts of real estate will be subject to reassessment thanks to Proposition 19. Subject to limitations, only the parent’s principal residence or farm will be excluded from reassessment if (and that’s a big if!) the children reside there. Our lawmakers are creating rules about how many children have to live there for how long.
The intergenerational preservation of the property tax base resulted in similarly situated homeowners paying dramatically different government services taxes. This violated the “horizontal equity” principle of fair taxation that similarly situated people should pay similar tax amounts so that everyone can have confidence in the system. The proposition is a partial remedy.
Proposition 19 was also designed to line realtors’ pockets by generating more sales and commissions. Its leading proponent was the California Realtors Association, which spent $36 million to promote it, while the Howard Jarvis Taxpayer Association spent $40,050 to oppose it.
Lawyers will almost certainly challenge the proposition as unconstitutional for deceptive packaging and marketing—advocates sold it to the public as a way to protect seniors (it allows homeowners who are either over age 55, have severe disabilities, or are victims of natural disasters or hazardous waste contamination, to purchase a new residence but retain their property tax assessment from a prior home).
Proposition 19 won’t affect people who own property in a corporation, limited liability company, or other legal entity (a trust is a relationship and not a legal entity). The parent-child exclusion only is available to direct transfers between parents and their children (and qualified grandchildren). In some cases, it may make sense to transfer the property out of the entity to the entity owners individually so that they can then make a last-minute direct transfer qualifying for the parent-child reassessment exclusion.
Now is your last chance to preserve your valuable property tax base for your children (and qualified grandchildren). Today, parents and children can transfer — by inheritance, gift, or sale — a primary home of unlimited value, and it won’t be reassessed to market value, even if they leave it vacant or rent it out. They can also transfer rental property, commercial property, and vacation homes while exempting up to $1 million of current assessed value from reassessment. Properties getting this tax break usually have a market value far exceeding assessed value.
Before making any transfers, consider your financial planning for your quality end of life experience (can you afford to make the transfer?). Keep in mind that many parents have regretted making tax planning gifts to their children. The risks are that the kids might call less often or lose the property in divorce or bankruptcy.
How long the younger generation plans to hold the property and their ability to pay the property tax are also factors. Consider that the kids will pay much more income tax (due to the carryover basis) if they sell a property you give them now rather than selling it after inheriting it from you.
An estate lawyer with a tax background can help coordinate the complex income, estate, and gift tax considerations with the possibility of Proposition 19 planning. A popular strategy is to gift the property to qualified loved ones before February 16, 2021, directly to the kids or in trust for their benefit (a trust can provide better overall tax planning). Few property owners will make transfers in the weeks ahead as most conclude that the risks outweigh the rewards.
About the Author:
John O’Grady leads a full-service estate and trust law firm in San Francisco. His practice includes Estate Planning & Administration, Probate and Trust Litigation.