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Potential Debilitating Property Tax Increase for California Heirs

Prop 19 would limit the availability of the parent-child exclusion for real estate tax assessments.

California continued the attack on Proposition 13 in the last election through a few different propositions. Proposition 19 was one of the culprits. Prop 19 contains two important changes in California property tax assessments, one of which will financially impact many estates if action isn’t taken immediately.

Two Primary Provisions

The two primary provisions in Prop 19 address: (1) changes to the parent-child exclusion for residential transfers, and (2) changes to the transfer of taxable value for certain individuals and the area in which the transfer can occur. I’ll focus on the first provision regarding the parent-child exclusion. Briefly, the second provision expands the class of homeowners who can transfer their taxable value to include certain individuals such as victims of wildfire or other natural disasters, regardless of age or disability status. It removes the restriction that the replacement home must be in the same county as the old home. Now such replacements must simply be in California. The new law also allows homeowners to buy a replacement home that’s worth more than their old home, provided the increase in value is added to the transferred taxable value of the old home.

Changes to Parent-Child Exclusion

As to the first provision in Prop 19, is your client thinking about transferring their primary residence to their children when they pass? If so, have they evaluated whether their children will be able to afford the property tax, if the property is reassessed to current market values? Other than their primary residence, have they considered transferring any other real property to their children?

Prop 19 limits the availability of the parent-child exclusion for real estate tax assessments. This portion of Prop 19 takes effect on Feb. 16, 2021. If your client plans on finding a way to work around this new law, they need to do so immediately.

Under current law, when a parent transfers ownership of a principal residence to a child, the property’s value for tax assessment purposes isn’t reassessed. This is true regardless of how the child uses the residence. In California, transferring a parent’s home to one or more children is permissible under current law without triggering reassessment, whether the child or children use the home as a vacation home, a rental property or a primary residence.

In addition to the principal residence exclusion, current law allows for the first $1 million of assessed value (not fair market value) of any real property, including vacation, rental and business property, which is transferred to a child to be excluded from property tax assessment.

New Exemption Much More Limited

Prop 19 repeals the existing exemption for transfers between parents and children, and between grandparents and grandchildren whose parents are deceased, and replaces it with a much more limited exemption. For transfers occurring after Feb. 15, 2021, the parent-child exclusion is limited to transfers of a principal residence as well as to certain farm property. The child or children must use the residence as their own principal residence. If they don’t use the home as their primary residence, the home will be reassessed. Additionally, even if the child uses the residence as his or her own, Prop 19 will only exclude up to $1 million of value over the existing assessed value. The $1 million is the exclusion for 2021 and is indexed for inflation based on the California House Price Index. The entire taxable value of inherited primary residences doesn’t have a 2% cap on assessment growth and instead is subject to increases in taxable value at market rate.

Effect on Trusts

The change to the parent-child exclusion will affect many common estate planning trusts established before Prop 19 such as qualified personal residence trusts (QPRTs). A QRPT allows the transfer of a residence to a trust. The residence can still be occupied for a fixed number of years by the person establishing the trust; typically parents. The parents continue to live in the residence as their primary residence. At the end of a fixed number of years, the residence transfers to the parents’ heirs; typically their children or a trust for the benefit of their children. Most parents who establish QPRTs continue living in the home after the fixed term established by the trust ends. They may do so, but parents need to pay rent to the trust or to their children, depending on who owns the residence at the end of the fixed term.

Under existing law, when the children become the owners, they would qualify for the parent-child exclusion. But once Prop 19 takes effect, the children will need to use the residence as their primary residence or trigger reassessment. They can’t rent it back to the parents. Furthermore, if siblings are entitled to the residence at the end of the fixed term, they need to move in together and share the home to qualify for the exemption. If parents have QPRTs whose fixed term ends on or after Feb. 16, 2021, the value of their home may be reassessed to its current value.

Act Now

The majority of Californian’s who voted for and against Prop 19 likely didn’t understand the meaning of the law or why it was even on the ballot. No one understands the fiscal impact of the law. The Fiscal Impact Statement provided with the Proposition states the following:

Local governments could gain tens of millions of dollars of property tax revenue per year. These gains could grow over time to a few hundred million dollars per year.

Schools could gain tens of millions of dollars of property tax revenue per year. These gains could grow over time to a few hundred million dollars per year.

Revenue from other taxes could increase by tens of millions of dollars per year for both the state and local governments.

Most of this new state revenue would be spent on fire protection.

The use of “could” in a fiscal impact statement basically means the drafter of the proposition and the individual who voted for the proposition had no interest in any fiscal impact. The proposition is an intended erosion of Prop 13 and nothing more. If it will harm your clients’ estate plan wishes or worse yet, their heirs, the time to act is now. If your clients have any interest in using the current law to transfer property to their children, the transfer must occur before Feb. 15.

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