Californians were faced with a monumental decision when they completed their election ballots this year. Many agonized over how to vote, weighing the options, going back and forth. For some, taxes were the overriding consideration; for others, it was about personal liberty or public health. But as the drama of election night unfolded, there can only have been one question on people’s minds: will Proposition 19 pass?
Prop 19 did indeed pass, and in doing so has swept away one of the enormous privileges hitherto bestowed upon homeowners by the tax system.
Under the current law, a parent can transfer property to a child and that transfer does not amount to a “change of ownership” for property tax purposes. Why is that important? If someone bought a home 30 years ago for $200,000 and the property is now worth $1.5 million, that person is currently paying very low property taxes based on the original value of the home. If they were to sell or gift the home, those property taxes would be reassessed and the new owner would pay vastly higher taxes based on the $1.5 million value of the home. However, there is currently an exception allowing a parent to transfer ownership of property, whether during life or at death, and that transfer will not amount to a “change of ownership.” This means that if a child inherits their parents’ house, there will be no increase in property taxes.
The new law effectively abolishes the parent-child exclusion for children who inherit the property on or after February 16, 2021. In the example above, instead of paying property taxes based on a $200,000 valuation, the child will pay property taxes based on a $1.5 million valuation. The only way for the child to avoid this unfavorable treatment is if he chooses to live in the inherited property. Even then, he can only avoid reassessment up to an assessed value of $1 million. So in this example, even if the child chose to live in the house, he would still be paying increased property taxes in relation to the $500,000 value beyond the $1 million cap.
What to do: consider gifting your property before February 16, 2021; the current rules will remain in place until then. A word of caution, though: gifting in trust is often more appropriate than gifting outright. In addition, no decisions around gifting should be made without first considering the impact on cost basis. In the example above, if the child inherits the property upon the death of the parent, the property receives what is known as a “step up in basis.” That means that if the property is at that time worth $1.5 million and it is sold for $1.5 million, no capital gains tax would be paid. By contrast, if the property is gifted during the parent’s lifetime, the child will lose that basis step up. If he decides to sell the house, he will be deemed to have purchased it at the original $200,000 fore the purposes of calculating whether any capital gains tax is payable. Estate and gift tax considerations may also factor into the equation, depending on the circumstances.
rushing to gift property before the February 16, 2021 deadline may or may not be the right strategy. Each case needs to be assessed on its merits.