On November 3, 2020, California voters passed Proposition 19 by a narrow margin. Proposition 19 enacts significant changes to the State’s property tax laws—some positive and some negative.
A primary benefit of the Proposition is that it allows qualifying California residents (age 55 and above, physically disabled, or victims of natural disaster) to sell their current home and carry their property tax base from their prior home to their new primary residence as long as the new home is purchased within 2 years. Previous to Proposition 19, this benefit was allowed only between participating counties, could only be done one time, and the new home would have to be of equal or lesser market value than the old home. As of April 1, 2021, Proposition 19 enables taxpayers to utilize this benefit within any county in California, to claim this benefit up to three times in their lifetime, and the new home can be of higher value than the previous home. (Please note, if purchasing a home of higher market value, additional assessment will apply to the incremental increase in market value).
Although this is generally great news, there are some drawbacks with Proposition 19 for those looking to transfer property to their children. Under current rules, a homeowner may transfer a principal residence to their child without a value reassessment for property tax purposes. Further, under current law, homeowners can transfer up to $1 million of assessed property value ($2 million for married couples) to their children for non-principal residence, such as rental properties or second homes. However, as of February 16, 2021, Proposition 19 enacts further restrictions regarding the transfer of property to children. In order to qualify for the principal residence exclusion, the receiving child must use the residence as their principal residence within one year of the transfer, and only the first $1 million of additional assessed value is excluded upon reassessment. Further, the non-principal residence exclusion has been completely eliminated, so any transfer of property not considered a principal residence to the child will require a full reassessment for property tax purposes.
Though the immediate reaction to this new law may prompt you to consider gifting the property to your children by February 16, 2021, there are other considerations to take into account. Since the transfer of property to a family member is considered a gift there are both income tax and estate / gift tax implications that need to be carefully evaluated before proceeding.
For income tax purposes, as a gift of the property also transfers the original cost basis to the recipient, there is no “step-up in basis” associated with a gift made during one’s lifetime. Accordingly, if the recipient family member sells or plans to sell the property within a short time after transfer, they will be subject to potential tax on the full gain as determined using the original cost basis. Note that to receive a “step-up in basis” and avoid the income tax consequences, the ownership of the property would need to stay with the current owner until their passing.
For Gift / Estate tax purposes, this transfer would be considered a taxable gift for estate tax purposes, reducing your lifetime gift exemption. With the lifetime gift exclusion currently at $11.58 million per person, the gift of your principal residence may not seem significant, but with the strong possibility that the lifetime gift exclusion will be reduced in the coming years, transferring the property to your children now may ultimately increase your likelihood of estate tax down the road.
For the reasons noted above, Proposition 19 puts many homeowners in a tough position and every situation is unique due to each person’s relative personal wealth and desired use for their principal residence after passing. If you are considering transferring property before February 15th, 2021, we recommend that you speak with your children and attorney to determine the best result for everyone before making a final decision. Your representative at DKC can also provide some assistance with regard to the income tax and estate / gift tax implications of any transfers.