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The Real Estate Tax Implications of California Prop 19

California Prop 19, also known as “The Home Protection for Seniors, Severely Disabled, Families, and Victims of Wildfire or Natural Disasters Act,” went into effect on February 16, 2021. This blog will review the three classes of people who can benefit from this legislation, as well as the strict limitations it introduces to parent-to-child property transfers.

Those who can benefit from Prop 19 are 1) people over age 55, 2) disabled persons, and 3) disaster and wildfire victims. Prop 19 allows these classes to move their property tax assessment to a new personal residence anywhere in California. Previously, this was only possible in participating counties.

On a more challenging note, Prop 19 changes the requirements for the parent-child property tax exclusion. A property must now be the parent’s primary personal residence at the time of the transfer, whether by gift or death, and must become the child’s primary personal residence immediately after the transfer. If these requirements are not met, the property value will be reassessed and subject to a substantial increase in property tax. Prop 19 also eliminates the parent-to-child exclusion on investment property.

Lastly, Prop 19 imposes a new limitation for personal residence properties. Only the base year assessment plus $1 million is excluded from reassessment. So if the parents had a property tax assessment of $100,000, but the property is now worth $2 million, there would be a partial reassessment exclusion, and the rest would be reassessed.

How can we mitigate the impact on real estate taxes for estate planning purposes?

Under Prop 19, if a parent transfers their property to their children as a gift during their lifetime, the children take the parents’ basis (the amount of their capital investment in property for tax purposes), and there’s no basis adjustment on death. So there’s really no incentive to do this. If the children inheriting the property intend to sell it right away, the parents should hold on to the property, so the children get the step-up in basis, a tax benefit in which the property is valued as if the children purchased the property on the parent’s date of death. This minimizes the capital gains tax the children will have to pay.

What about investment property? One option is to use an LLC as a way of transferring property without causing a reassessment. This process involves three phases:

  • Phase 1: The parents transfer the property into an LLC and then gift 50% of the interest to the children. This avoids reassessment, and we can claim it as a proportional interest transfer. After enough time has passed, we dissolve the LLC, so the property is now owned 50% by the parents and 50% by the children.
  • Phase 2: The parents now give 1% of the property to the kids. This will cause the property to be reappraised, but the reassessment on that 1% will be a very small amount. Next, the parents and children create a second LLC that is owned 49% by the parents, 51% by the children. Again, the proportional interest rule excludes this from reassessment.
  • Phase 3: When the parents do pass on, the children will inherit the 49% owned by the parents. What’s important here is that since the children already owned 51%, we will not cross the threshold of more than 50% ownership passing from the parents when they die. So there will still be no reassessment.

Given the complexity of new legislation like Prop 19, taxpayers will need the assistance of a tax advisor to avoid unexpected property taxes that could adversely affect their estates. Certified Tax Planners learn strategies and concepts that save clients tens of thousands on their taxes. Serve fewer clients better, and earn more while working less. Find out more by clicking here.

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