How will Prop 19 affect my taxes if it passes?
11/6/20 Update: Prop 19 narrowly passed. Those over age 55 will have more options to move their home’s property tax base — while some families may want to consider gifting a home before February 16th, 2021. Be sure to consult your professional advisors before making any significant changes.
Do you plan for your child to inherit a home in California? If so, pay attention to recent developments related to Prop 19 and the impact it is likely to have on your property taxes.
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2020 Developments related to Prop 15 and Prop 19 (and why they matter)
This year we have two California propositions (Prop 15 and Prop 19) on the ballot that could alter the limits on tax reassessments on real estate under Prop 13 and subsequent related propositions. This could have a big impact on families as many intend to pass on the family home to their heirs.
Let’s start with the basics. What does Prop 13 do? Prop 13 limits property tax increases to 2% per year – compared with typical home price appreciation of say 5% per year. As a result, longtime California homeowners typically pay property taxes on a lower tax base than the actual value of their homes.
But unfortunately it seems like the picture is about to become a little bit less rosy.
Ignore the Commercials: This Changes Property Taxes for Californians
Prop 15 (which removes Prop 13 protections on commercial and industrial real estate) has been getting all the headlines, but it is actually Proposition 19 that could have the larger impact on families in our state. While Prop 19 establishes a fire protection fund, it makes many changes to established rules on property tax assessments.
Seeing that the recent median sales price of a single-family home in La Jolla was $2,035,000, property taxes are not insignificant to people in the San Diego area [1]. For decades, children or grandchildren who inherit the family home (or even up to $1M of other property - like a rental home) have been protected from a tax reassessment in California. Let’s say a mother passes away and leaves the family home to her daughter. The daughter will pay taxes based on the same rate as mom. If Mom had paid tax on the $1M purchase price of the home - even though the market value is $2M - the inheritor daughter would continue to pay tax on the $1M purchase price instead of the $2M market value under current law. If the daughter isn’t sure she wants to move back into the home, or wants to rent the out home, she can do so knowing the tax bill will not double given the current market value of $2M.
Prop 19 has drawbacks and benefits
If Proposition 19 passes, all of this would change. First, the daughter mentioned in the scenario above would have to move back into the family home as her primary residence to receive any sort of protection from reassessment. Second, only the first $1M of tax base is protected – so the home she inherits would be reassessed for the difference between the original $1M tax base and the current market value of $2M, resulting in a big tax bill.
Prop 19 does expand some provisions that could potentially benefit California residents. It expands the ability for seniors and disabled persons to take their property tax base to another home, even a more expensive one, anywhere in the state. It also dedicates funding to fire protection which is of course sorely needed in our state.
Planning for your estate with new developments in mind
For many families, their home is their largest asset, and they want to pass it on to their heirs. This new provision may force many families to sell because they do not have the ability to pay what would be a much higher property tax bill. A representative from the San Diego County Assessor’s office expects a 30% increase in reassessments that would be excluded under current law [2].
These new ballot measures are a reminder that your estate plan needs to change to work with prevailing laws to make sure that your successors and heirs have the flexibility to do what is necessary. For example, instead of equal distributions to heirs, consider allowing the estate to distribute fairly but not necessarily equally (“non-prorata”) to heirs. If one child gets the house and the other gets the investment account, will the one who gets the house be able to pay a higher property tax bill?
For those with larger estates, they may want to pass down real estate to heirs during their life, forgoing some or all of a step-up in cost basis (for capital gains taxes) but preserving the assessed property tax value. If Proposition 19 passes, transfers before February 15th, 2021 would be allowed to be grandfathered under the old law.
Take the time to work with your professional team to ensure that your plan has the appropriate tradeoffs between income and estate taxes, property taxes, control, and flexibility. And be sure take into account the value, liquidity, and possible liabilities of the assets that you’ll leave behind. Contact us with any questions on this matter.
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Contributor
Chris Jaccard, CFP®, CFA is a lead advisor with Financial Alternatives in La Jolla, CA. When he’s not working on home improvement projects or trying to keep up with his kids, he loves to help successful families consider their alternatives and make better financial choices with the EXPERT™ Advisory Process. Schedule a time to chat about your situation or the latest project.
Sources:
Barbara Leinenweber, Coldwell Banker
Jeff Olson, San Diego County Assessor’s Office