ALL THINGS TAX

Proposition 19 makes wholesale changes to
the Parent-Child Exclusion

Proposition 19, enacted by California voters on November 3, 2020, changes the rules relative to transfers of property between parents and children. This affects reassessment of property values and the effect on property taxes.

The current law – Proposition 58

Under the current law, parents can transfer real property to their children without triggering a property to reassessment, in two scenarios:

1. A parent may transfer the assessed value of their principal residence to their children by gift or at death, without limitation;
2. Each parent may transfer other real property (including vacation homes or commercial property) of up to $1,000,000 of assessed property value without causing reassessment.

Proposition 19 (effective February 16, 2021) changes this.

Proposition 19 repeals the existing exemption for transfers between parents and children and substitutes a much more limited exemption.

1. Under Proposition 19, the parent-child exemption is limited to transfers of the parent’s principal residence and only if the transferee child occupies the property as their principal residence;
2. Transfers of the property tax assessment is subject to a cap of $1,000,000. If the increase in value at the time of transfer is less than or equal to $1,000,000, there is no adjustment. If the value of the property at transfer is more than $1,000,000, the increase in value after the first $1,000,000 is added to the taxable value.

Planning for Parent-Child Transfers Before February 16, 2021

Major property tax savings can be realized by gifting or sales of real property to children outright, or into trusts or entities to take advantage of the current Proposition 58 rules before it is gone. The current Federal Estate and Gift Tax scheme ($11,580,000 exclusion in 2020) allows property owners to make substantial gifts of properties to children without incurring federal gift tax. However, gifting is, in many ways, a two-edged sword. Real property transferred by gift takes a carry-over basis. Carry-over basis means the recipient of the property assumes the donor’s basis. Basis is an important concept in tax law. It is the donor’s purchase cost plus certain improvement expenses. For example, a parent’s residential home purchased 30 years ago for $100,000 with $50,000 of improvements would have a basis of $150,000. If the parents gift their home to a child, the child assumes a carry-over basis of $150,000. If the child, in turn, sells the home, the child is subject to capital gain based on the difference between the sales price and their carry-over basis. That future gain could be substantial. Consider if the property increased in value to $750,000. Then the taxable capital gain would be $600,000.

On the other hand, real property inherited at death receives a step-up in basis which can reduce the capital gain in a future sale. In the previous example, if the child instead inherits the property upon the parent’s death, the basis on the property will be “stepped-up” to its fair market value at date of parent’s death. Continuing the example: if property has a fair market value of $750,000 and is sold for $750,000, the capital gain is “0.”

If a child is likely to sell the property after the parent’s gift, the property tax savings of gifting may pale compared to the income tax benefits realized from inheriting the property at parent’s death.

Other Elements of Proposition 19

Proposition 19 makes other changes that will benefit homeowners. Prop 19 expands the class of people who qualify for a transfer of the taxable value of their home to other property. Under current law, only homeowners over 55 and certain disabled persons could make use of this benefit. Transfer is permitted only to replacement property of less or equal value. After April 21, 2021, the class of homeowners who can avail themselves of this benefit is extended to victims of wildfires or other natural disasters, regardless of age or disability. Before Proposition 19, the replacement home had to be in the same county. Now the replacement home can be anywhere in California. Further, under the new law, the replacement home can be worth more than their old home, provided that the increase in value is added to the transferred value of the old home.