This past November, California voters approved Proposition 19, The Home Protection for Seniors, Severely Disabled, Families, and Victims of Wildfire or Natural Disasters Act. The new law overhauls the way property taxes are calculated when affected properties change hands. Its changes will be felt first and foremost by owners of homes whose market value is much greater than its assessed value. But it may also impact their children who had expected to inherit their parents’ low property taxes.
What’s Changed for Homeowners?
For several decades, California law has allowed residents of certain counties to transfer the assessed value of their home to a new home of equal or lesser value once in a lifetime. However, this allowance only applied to seven counties statewide. Effective April 1, 2021, Prop 19 expands these provisions to the entire state of California as follows:
-Eligible homeowners include those over age 55, the disabled, and victims of disaster.
-The limit on lifetime transfers increases to three (unlimited for disaster victims.)
-The replacement home need not be of equal or lesser value.
Let’s suppose Mom and Dad, both age 65, want to downsize from the Alameda county home where they raised their children. Since they bought the house, its fair market value has increased to $1,000,000. But the assessed value for tax purposes is a mere $200,000. Assuming a 1% tax rate, the property tax bill is $2,000.
Before Prop 19, if Mom and Dad moved outside the eligible counties, they would have been subject to a tax reassessment. A $1M replacement property would have meant a property tax bill of $10,000 – a whopping $8,000 tax increase. A big incentive to stay put!
Prop 19 removes that barrier to -relocating. In the same scenario, post-Prop 19, Mom and Dad would be able to keep their original assessed value. If they moved from their Alameda county home to a different $1M home within the state of -California, their assessed value would remain $200,000. This means their property tax bill would remain $2,000.
The new property tax protections apply even for replacement properties of greater value. Eligible homeowners preserve their assessed value up to the sale price of the original home, up to $1M. Any additional amount paid for the new home is added to the old assessed value to determine its new assessed value.
For example, if Mom and Dad move to a $1.5M replacement home, their new assessed value is $700,000. That number is the sum of their original assessed value ($200,000), plus the extra cost of the new home ($500,000). Thanks to Prop 19, they end up with a tax bill of $7,000 instead of the $15,000 they’d otherwise pay.
The upshot? More Californians can relocate without taking a big property tax hit.
What’s Changed for Homeowners’ Children?
Unfortunately for some, Proposition 19 has made it much harder to pass on a property tax break to future generations. In the past, parents could gift or bequeath a primary residence – along with its favorable assessed value – to their children. The children were then free to use it any way they wanted. Parents could also transfer $1,000,000 worth of other properties, e.g. rental or vacation home, without triggering reassessment.
As of February 16, 2021, Prop 19 eliminates almost all of those perks. For any property other than the parents’ primary residence, the parent-child exclusion no longer applies. Even in the case of the parental primary residence, children receiving the property must make it their primary residence to preserve the assessed value. Further, the exemption will only -apply to the assessed value at the time of the transfer plus $1,000,000.
For example, let’s assume Mom and Dad’s home is worth $1.7M, and has an assessed value of $1.2M. They leave it to Junior, who makes it his own primary residence. The difference between the market value ($1.7M) and the assessed value ($1.2M) is less than the $1M limit. Junior inherits his parents’ assessed value and pays the same $12,000 property tax that his parents paid.
Now suppose Mom and Dad’s home had appreciated to $2.6M. The difference between the market value ($2.6M) and the assessed value ($1.2M) is $1.4M, which exceeds the $1M limit. So the tax base is adjusted per a Prop 19 formula. Junior’s new assessed value is the market value ($2.6M) less the $1M cap. This results in a $16,000 property tax bill, a third higher than his parents paid.
If Junior declined to move into the family home, and did not make the property his primary residence, the transfer would not qualify for the parent child exclusion. The property transfer would then trigger reassessment and jump to $26,000, more than double his parents’ tax bill.
What’s a Homeowner to Do?
Moving forward, Prop 19 will certainly be a consideration when making decisions about the family home. But Mom and Dad also need to consider other factors, not least the income tax implications of selling.
While Prop 19 does allow for potential property tax savings in the event of a move, the income tax due on the sale of the property could still be substantial. For long-time residents of desirable neighborhoods, appreciation on the family home could be significant. Gains could easily exceed the $500,000 capital gain exclusion for those who are married filing jointly. In cases such as these, Mom and Dad might still opt to stay put to in order to avoid a large income tax bill.
For most Californians, it comes down to this: If realizing capital gains upon the sale of your home was the primary obstacle to relocating, nothing about Proposition 19 changes that. On the other hand, if an increase in property taxes was the big stumbling block, then you have a new reason to revisit your financial plan. You might find a much-coveted move is now within your reach.