Prior to the passage of Prop. 19, when a parent transferred ownership of a principal residence to a child, the property’s value for tax assessment purposes was not reassessed. A parent was able to transfer without triggering reassessment, whether the child or children use the home as a vacation home, a rental property or a primary residence. This was especially beneficial for parents who have homes in high-value property counties e.g. Los Angeles, San Francisco.
The law also allowed for the first combined $1 million of assessed value (not fair market value) of other real property, including vacation, rental, and business property, which the parent transferred to their child to be excluded from property tax assessment.
In other words, no “change of ownership” occurred when a parent passed or transferred their primary residence and any other real estate properties worth less than $1 million. The only time reassessment happened was if the combined total worth of investment or business properties were worth more than $1 million.
Well, that’s no longer the case thanks to the passage of Prop. 19!
Under Proposition 19 all real property will be reassessed at death and it 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 February 15, 2021, the parent-child exclusion is limited to transfers of a principal residence as well as to certain farm property. If your heirs do not use the home as their primary residence, the home will be reassessed at full market value. Additionally, even if the child uses the residence as his or her own, Proposition 19 will only exclude up to $1 million of value over the existing assessed value.
This applies to each parent separately.
There is no exclusion or exemption for rental/investment/business properties, they will be reassessed at their fair market value.
Example: If parent bought home in the 70’s for $100,000 and the parent pay property taxes based on the original $1000,000 assessment but it is now worth $3 million (FMV).
- If the Child lives in the inherited home: the amount protected from reassessment at the time of inheritance is $1.1 million (original $100,000 + $1 million). The amount up for reassessment is $1.9 million (FMV- protected assessment). The child now has an assessed value of $2 million ($1.9 million reassessment + $100,000 original assessment). This means that the child will have to pay property taxes on $2 million.
- If the Child does not live in the inherited home: the child will pay property taxes on the full $3 million.
How Prop. 19 affects QPRT:
If you, a parent or grandparent, created a QPRT (Qualified Personal Residence Trust) with a term ending AFTER February 16, 2021, you’ll need to reevaluate your trust.
If you’re wondering what a QPRT is, simply put people use this to transfer their primary residence to a trust. They would continue living in their residence and after a fixed number of years the residence would be transferred to the person’s heirs/trust. After the fixed term the person can still live in the residence but they would have to pay rent to the trust/heirs.
Under Prop 19, the children will need to use the residence as their primary residence or trigger reassessment. They cannot 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 February 16, 2021, the value of their home may be reassessed to its current value.
Some things you can do now before February 15, 2021:
1. Transfer the property to your heirs.
-This makes the most sense if your tax base is low
-The down side is you may trigger estate and gift tax (There is no CA estate tax, only Federal, Federal Estate Tax is triggered if the estate’s gross value is over $11.7 million)
-Your heirs should charge you rent in order to avoid using their gift tax exemption
-You’ll be giving up valuable capital gains tax benefit
-The house is no longer yours and vulnerable to whatever issues your heirs may have e.g. divorce, death, lawsuits
-If it’s a rental property, do you need the income generated from it? If yes, then it may not be a good idea to transfer it. If not, then it may be an option.
-Must file a gift tax return
2. Have the heirs file a California Claim for Reassessment Exclusion Form
-Must be done within 1 year of a transfer
-Must have documents such as will or trust
-Must be a transfer between parents and children
-Applies to primary residence and/or the first $1 million of the factored base year value of other real property
3. Transfer the house to a Irrevocable Trust
-Downside is that it can’t be undone
-If the house is sold the money remains in the trust
-If you apply for Medicaid within 5 years of transferring, you may be subject to a Medicaid penalty period
-Preserves your step-up basis for capital gains tax purposes
4. Transfer the property to an LLC or Corporation
-Your heirs would inherit shares/ownership not the property itself
-Recommended if you have multiple heirs and no more than one person would own 50% of the company