On November 3, 2020, California’s Proposition 19 (Prop 19) passed by a slim majority. This constitutional amendment makes two major changes to California’s property tax system:
While the former change is a welcome news for homeowners by expanding their ability to transfer their assessments, the latter poses major tax consequences for people intending to transfer real property to their children or grandchildren.
Current law under Proposition 58 allows property owners to transfer real property to a parent or child with the recipient permitted to keep the donor’s property tax basis, provided (1) the property was the donor’s primary residence, or (2) the total assessed value of the property is less than $1 million. Proposition 193 extended this benefit to certain transfers between grandparents and grandchildren.
Beginning February 16, 2021, Prop 19 limits the parent-child and grandparent-grandchild exclusions to transfers of a primary residence that will be used as the recipient’s primary residence or of a “family farm.” If the fair market value of the property (whether a primary residence or family farm) at the time of transfer is less than $1 million greater than its assessed value, the property will retain its original assessed value. If the property is worth over $1 million more than its assessed value, the property will be reassessed, but $1 million will be excluded from reassessment. The exclusion must be claimed either at the time of purchase or transfer or within one year thereafter.
“Family farm” is defined as “any real property which is under cultivation or which is being used for pasture or grazing, or that is used to produce any agricultural commodity, as that term is defined in Section 51201 of the Government Code as that section read on January 1, 2020.” Government Code section 51201 defines “agricultural commodity” as “any and all plant and animal products produced in this state for commercial purposes, including, but not limited to, plant products used for producing biofuels.”
Example of Prop 19 In Action
On paper, Prop 19 seems confusing, so a practical example might help: Mary owns her primary residence, which is worth $1 million and assessed at $300,000. Mary also owns a rental property worth $900,000 and assessed at $200,000. Mary has one child, John, to whom she will leave both properties.
Before Prop 19, John could inherit both properties and continue to pay the same property taxes Mary would have via the parent-child exclusion.
After Prop 19, if John inherits the rental property, it will be reassessed at fair market value because it was not Mary’s primary residence. If John inherited Mary’s primary residence and chose not to use it as his primary residence, it would also be reassessed at fair market value. But if John chose to use it as his primary residence, there would not be a reassessment, as the difference between the primary residence’s fair market value ($1 million) and assessed value ($300,000) is less than $1 million.
However, assume that the fair market value of the primary residence is $1.5 million, instead of $1 million, with the same assessed value of $300,000. In that case, the property would be reassessed, since the fair market value ($1.5 million) is greater than $1 million more than the assessed value ($300,000) – but there would be a $1 million exclusion from assessment, so the residence would be reassessed at $500,000 ($1.5 million - $1 million).
Date of Change of Ownership Remains the Same
Notably, Prop 19 does not change current law on determining a property’s date of change of ownership. The date of change of ownership for properties that transfer by will or intestate succession will continue to be the grantor’s date of death.1 For properties that transfer by revocable trust, the date of change of ownership will continue to be the date the trust becomes irrevocable as the result of the death of the settlor.2 Thus, Prop 19 will apply to transfers where the date of change of ownership is on or after February 16, 2021. It will not apply to transfers where the date of change of ownership is on or before February 15, 2021.
This is especially important for ongoing trust and probate matters, where title to property may not have transferred by the time Prop 19 takes effect, but the grantor died, or the revocable trust became irrevocable, prior to Prop 19 taking effect.
Implications of Prop 19
The tax implications of Prop 19 are big – particularly where property has been owned for a long period and has a low assessed value compared to its market value. Prop 19 will especially affect transfers of property in the Bay Area and other parts of California where property values have soared over the past decade.
Tax and estate planning professionals should advise their clients of the potential ramifications of Prop 19 and whether a change in their estate plan would be beneficial. Parents who intend to leave property to their children should consider their children’s long-term plans for the property to ensure that the best tax-saving strategy is adopted. If their children intend to sell the property, reassessment might not be a concern, and it might be prudent to keep the property until the parents’ death for the step up in basis and to avoid significant capital gains tax. On the other hand, if their children intend to keep the property long-term, reassessment might not be optimal, and an earlier transfer prior to Prop 19 taking effect might be advisable.
The parent-child and grandparent-grandchild exclusions as we know them will only be available until February 15, 2021. Be sure to advise your clients of the potential consequences of Prop 19 and whether they should take advantage of the parent-child or grandparent-grandchild exclusions while these tools are still available.
1.Cal. Code Regs. tit. 18, § 462.260(c).
2. Cal. Code Regs. tit. 18, § 462.260(d).