CALIFORNIA PROP. 13 PROTECTIONS, PROP. 19 STRATEGIES

(Please note: this page was substantially updated on February 17, 2021, as legal strategies must change after the Prop 19 deadline. We keep our clients updated on this subject with frequent webinars. Look for the Prop 13 playlist)

Prop. 19 Radically Altered Prop. 13 Rules on Inheritance

The property tax situation in California has again been dramatically altered by the passage of the landmark California tax Proposition 19 in November 2020, which went into effect Feb. 16, 2021.

That’s because with limited exceptions—and barring aggressive countermeasures—California Prop 19 eliminates a parent’s ability to leave to their children or grandchildren their Proposition 13 taxes and tax base. Nearly all Property will be reassessed at its current fair market value—with one very small exception.

Under Prop 19, the only Prop 13 tax base that can be transferred to your children is that of your principal residence to your child—and then your child themselves must live on the property as their principal residence. If that’s not enough, if the home is worth more than $1M, your home may be partially or entirely reassessed, with a partial or complete loss of your Proposition 13 tax benefit (See below, “What Parent to Child Exclusion Still Exists,” for more details).

In most cases, Prop 19 will effectively eliminate the ability of a parent to leave a low tax assessment to a child. Why? Because very few people who inherit their parents’ home will actually want to live in that home—and many homes are worth far more than $1M in California. That makes Proposition 19 a huge departure from current California law, with massive consequences for taxpayers who own California real estate.

New Prop 19 Strategy for Transfers After the Feb. 16, 2021 Deadline

Did you miss the Feb. 16, 2021 deadline to transfer a property to your children before Prop 19 went into effect? CunninghamLegal has created an aggressive new Prop 19 strategy known as a Family Property LLC which may still enable you to avoid reassessments under Prop 19 to your kids when you pass away. This strategy is applicable to many families, and should be considered especially by high-net-worth families.

Quick Summary: What is Prop 13 California?

Proposition 13, which passed overwhelmingly in 1978, was an amendment to the California Constitution which rolled back residential property taxes on a principal residence to 1975 levels, capping them at 1% of assessed value (plus some local additions by county). Assessments were allowed to rise at a maximum of 2% a year—even though real estate prices in California continued to skyrocket.

Properties would be fully reassessed in value only when a change of ownership occurs either by death, gift, or sale. In other words, when the property is “transferred,” or what the California State Board of Equalization calls a “change in ownership.”

California Prop 58 Has Been Largely Eliminated by Prop 19

That simple formula has been modified in important ways over the years, including the 1986 Proposition 58, which excluded transfers from parents to children from reassessment, and also excluded the first $1 million of assessed value for any type of property transferred to children—including commercial and industrial properties—not just the family home.

Parents could then pass on their tax breaks to their kids on their residence, of any value. For other properties that aren’t the residence, two parents could combine their assessment exclusions to equal $2 million in assessed value being transferred to the children – even though the property might be worth $10M or more. In certain cases, grandparents could also transfer Prop 13 caps to grandchildren.

Later modifications even allowed people over 55 to take their Prop 13 caps with them to a new home, under limited circumstances.

The changes resulting from Prop 19 in the 2020 election are especially dramatic: Inheritance protections under Prop 58 have now been mostly voided by Prop 19, while the ability of people over 55 to move their prop 13 caps to new homes has been greatly expanded.

What Parent to Child Prop 13 Exclusion Exists Under Prop 19?

We said that children may still claim a limited exclusion from reassessments under Prop 19. If you don’t take pre-emptive action, such as establishing a Family Property LLC, then here are the rules, whether you give your child a home, or they inherit it. Remember that this applies only to your principal residence:

1. The child must move into the transferred or inherited home (or family farm) as their principal residence within one year, or the property will be reassessed at its full fair market value as of the date of death.
2. Assuming the child does occupy the home—if the value is less than the factored base year value plus $1 million (indexed for inflation), the base year value will not change. The math can get a little complicated:

Scenario A: Let’s take the example of John and Mary Smith. John and Mary bought a home in the 1980s for $100,000, but the home is now worth about $800,000. Doing the math, their tax base of $100,000 plus $1,000,000 would be $1,100,000. But since the home is valued at less than that (just $800,000), the tax base can be transferred to their daughter Ellen without adjustment. Ellen will pay the same property taxes as her parents.

Scenario B: But let’s say that John and Mary’s home is instead now worth $1,500,000. Again, we add the tax base of $100,000 plus a million to get $1,100,000. But $1,500,000 is greater than $1,100,000, with a difference of $400,000. We now add this difference to the base value of $100,000 and get $500,000. Ellen gets a break from full reassessment, but she still must now pay property taxes on a value of $500,000—assuming she continues to live in the home as her principal residence. Ellen must also proactively claim her exclusion, or pay the full hit of taxes on $1,500,000.

Is your house worth less than $1,000,000 now? How about 20 years from now, when you pass away?

3. What happens with multiple children under Prop 19? Must all the children move into the home as their principal residence? We honestly don’t yet know, as further guidance from the California courts or Legislature is needed.
4. Does Ellen have to occupy the house forever? How long must she live there as her “principal residence” before a reassessment is triggered? Again, we don’t yet know, and further guidance is needed.
5. Does this mean that ALL properties, principal residences or otherwise are subject to reassessment when ownership is transferred by inheritance or otherwise, so the math can be done on new property taxes? Probably yes. This will greatly increase the workload on assessment offices, and quite possibly create a significant backlog in cases.

As you can see, the complexity of these situations can rapidly multiply. At CunninghamLegal we are closely watching legal and legislative opinions to devise the best possible outcomes for our clients.

We will also continue to develop our Family Property LLC strategy to respond to this rapidly-evolving situation.

Prop 19 Also Changed the Rules for People Over 55

Prop 19 also changed the law to let eligible homeowners transfer their tax assessments anywhere within California, and lets tax assessments be transferred even to a more expensive home, with an upward adjustment. People over 55 can now do this three times during their life instead of just once. Other eligible people include those with severe disabilities.

Before the election, most of the Prop 19 attention focused on this change to the rules, although the inheritance exclusions will likely have a much greater impact. We have a webinar upcoming on this topic.

Regardless of your situation, we again suggest you work with an attorney during such transfers.

High Chance of Common Prop 13 Errors Demands Expert Legal Advice

We haven’t the space to detail all the ways that people mess up their Proposition 13 assessment caps—even during their lifetimes. If you have the slightest question about a transfer of property in a Living Trust or otherwise, we urge you to consult a competent California attorney. Here are just a few examples of the Proposition 13 mistakes people make:

• You change the title of a house, possibly triggering a reassessment.
• You name multiple beneficiaries in a Living Trust, which includes your house. Some of the beneficiaries are your children and some are not. As a result, the possibility of your children avoiding a reassessment may be lost.
• You move your industrial property into an LLC so you can protect yourself while renting it out, accidentally triggering a reassessment because you didn’t file the right form on time.
• You do not consider creating a Family Property LLC to protect your properties from reassessment when you die.
• Your heirs simply don’t know they have to file a claim for reassessment exclusion under Proposition 13 within three years, and they may lose it.
• Your child does not realize that under Prop 19 they must reside in your primary home to claim an exclusion after your death, and do not establish clear residency.
• A transfer occurs without proper registration with the state—and 20 years later, the new owner owes 20 years of “supplemental” back taxes at the enormously higher rate. In the Los Angeles example above, think perhaps $35,000 x 20!
• People think that they are passing on a “principal residence” but they haven’t lived there for years, and the state objects.
• People think they can pass on the exclusion for a multi-unit property, but they only occupy part of it, and the state objects.

We could go on and on. To make a long story short—the laws are complex, the laws are confusing, the situation is always changing, and the stakes are probably higher than you think.

Please get expert legal advice!

What Do We Do?

At CunninghamLegal, we guide savvy, caring families in the protection and transfer of multi-generational wealth.

We have dynamic, creative lawyers based in offices throughout Northern and Southern California, and we offer in-person, phone, and Zoom appointments. Please also consider joining one of our free online Estate Planning Webinars.

You can book an appointment for Estate Planning, Trust Administration, Asset Protection, or Advanced Tax Planning using the form on this page, by calling us at +1 866.988.3956, or by clicking here.

We look forward to working with you!

Best, Jim
James Cunningham Jr., Esq.
Founder, CunninghamLegal