Posted: November 17, 2020 |
Often viewed as the third rail of California politics, California’s Proposition 13 has provided property tax certainty and predictability since its enactment in 1978. However, with an ongoing global pandemic and national political chaos, it seems only fitting that 2020 would introduce instability into the tax world in the form of California Proposition 19. Entitled “The Home Protection for Seniors, Severely Disabled, Families, and Victims of Wildfire or Natural Disasters Act,” Proposition 19 loosens the strenuous restrictions on the ability of seniors, individuals with disabilities and victims of wildfires and natural disasters to sell their principal residence and to transfer the existing property tax base to a new principal residence. Unfortunately, Proposition 19 also severely undercuts the ability of parents to transfer real property to their children and allow the children to retain their parents’ low property tax base.
Transfer of Property Tax Base to New Principal Residence
California Proposition 13 provides that a property’s tax base will only increase (or decrease) in value by a maximum of 2% per year irrespective of the property’s fair market value. Thus, Californians who have owned their home for a number of years are likely to have a low property tax base in the home relative to the home’s current fair market value. Under California Propositions 60 and 90 (passed by voters in 1986 and 1988, respectively), California law currently allows a homeowner who is at least 55 years old or who is severely disabled a one-time opportunity to transfer the Proposition 13 property tax base from the owner’s current residence to a new residence purchased or constructed by the homeowner. Although there are many specific requirements the satisfaction of which are necessary to qualify for the property tax base transfer, in general: (i) the replacement residence must be situated within one of the 10 participating counties in the state; and (ii) the fair market value of the replacement residence must be equal to or less than the fair market value of the original residence (with certain adjustments for the passage of time between the sale of the original residence and the purchase or completion of construction of the replacement residence).
Effect of Proposition 19
Proposition 19 extends the benefits of Propositions 60 and 90 to victims of wildfire and natural disasters. The ballot initiative also allows homeowners to transfer their property tax base a total of three times anywhere within the state. Finally, Proposition 19 affords homeowners the ability to take advantage of the property tax base transfer even if the fair market value of the replacement residence exceeds the fair market value of the original residence - a restriction that previously disqualified a number of homeowners from utilizing the transfer mechanism.
Transfers of Property Tax Base in Real Property to Children
California Proposition 58 currently provides that a parent may transfer the parent’s principal residence to his or her children (whether by gift, sale or transfer at death) and the children can preserve the parent’s low property tax base in the residence going forward. To qualify for the exemption, it is not necessary for the children to reside in the residence after the transfer. For real property other than a parent’s principal residence, each parent has the ability to transfer real property (whether residential, commercial or industrial) to his or her children and to preserve up to $1 million of existing property tax base ($2 million in the case of transfers by two parents to their children).
For instance, assume that Becky owns commercial property that has a property tax base of $1 million and a fair market value of $9 million. Becky could transfer the entire commercial property to her children without any property tax reassessment.
Effect of Proposition 19
Proposition 19 turns Proposition 58 almost entirely on its head.
First, it appears (although it is far from certain) that the Proposition 58 exemption would now only apply to “family homes” and “family farms” for which the parent claims the homeowner’s exemption. Thus, it appears that it may no longer be possible for parents to transfer investment homes, apartment buildings, vacant land, commercial buildings or industrial property to their children and preserve the low property tax base.
Second, even in the case of a transfer of a parent’s principal residence to a child or children, in order to qualify under Proposition 58, Proposition 19 now requires the residence to “continue as the family home of the transferee.” In other words, unless one of the children is living in the home as his or her residence after the transfer, the children cannot preserve the low property tax base. Gone are the days of inheriting mom and dad’s house with the low property tax base and renting it out as an investment property. It is also unclear whether one child residing in the residence as a “family home” will be sufficient to satisfy the Proposition 19 requirements if title to the property is vesting in multiple children.
Third, even if a child is residing in the “family home” as his or her residence, the Proposition 58 exemption for transfers of a parent’s principal residence is no longer unlimited. Proposition 19 now requires taxpayers to undertake a tortuous calculation comparing (i) the existing property tax base plus a $1 million exemption to (ii) the fair market value of the residence and adding the resulting numbers to the existing property tax base to arrive at a blended property tax base going forward.
Needless to say, there are a number of issues, which the California Legislature will need to resolve when it enacts enabling legislation to make Proposition 19 part of the California Revenue and Taxation Code.
The new restriction imposed by Proposition 19 will apply to transfers occurring on and after February 16, 2021. It may still be possible to structure transfers to children to allow the children to retain their parents’ low property tax base under Proposition 58. Therefore, parents who are interested in adopting a gifting plan or otherwise making lifetime transfers to their children in hopes of qualifying under the current Proposition 58 rules should consult with their legal advisor immediately
Blaine M. Searle is a Partner at Ferruzzo & Ferruzzo, LLP. He regularly advises clients on matters involving federal income, gift and estate taxes as well as various state tax issues including California real property taxes. Mr. Searle represents clients in contract matters that arise in day-to-day business operations and has extensive experience in implementing mergers, reorganizations, acquisitions and sales of businesses. In addition, Mr. Searle frequently counsels clients on various estate planning strategies from simple trusts to more complex estate planning including the use of qualified personal residence trusts, intentionally defective grantor trusts, and transferring assets through limited liability companies.