CA Proposition 19 Impact and Planning
California Proposition 19 and the proposed tax changes in the Democratic Party 2020 Platform: Start thinking about property transfers now!
DEADLINE February 15, 2021
By Paul Polito, CPA
When I read my ballot book about Proposition 19, I knew it would pass because it had a popular “carrot”. California Seniors can now move their property tax base 3 times without a reassessment for property tax purposes within certain guidelines. Previously you could only use this once after age 55. That was the carrot!
The biggest part of the law that was explained poorly (my opinion) in the ballot book essentially eliminates the parent-child (or child-parent) exclusion from reassessment of Proposition 13 assessed values. Previously, a parent could transfer a primary residence of unlimited value plus other real property of $1 million (assessed value, not fair market value) to children (or vice versa) without the property being reassessed under our venerable proposition 13. This meant that property held in a family and passed down through generations would not be reassessed to the tune of $1 million (per donor spouse) each time the property was transferred. I know of a family that transferred a property in Hollywood assessed under proposition 13 at $300,000 which sold in 2016 for over $7 million. For years that property was leased on a triple net basis with taxes of around $3500 per year. The property was gifted down 3 generations over a 30 year period using this exclusion for each of 3 transfers.
Effective on or after February 16, 2021, this ability to transfer California real estate without a property tax reassessment is over. There is one exception if the child moves into the inherited property as a principal residence, but is limited to an additional $1 million of excluded assessment.
Before we talk strategy, let me set the table for you with some key provisions of the Democratic party’s 2020 tax platform which seems to be targeting tax favored wealth accumulation:
• Eliminate 1031 exchanges
• Eliminate preferential capital gains rates when Income exceeds $1 million.
• Abolish step up in basis at death for inherited assets.
• Return the gift and estate tax exemption and rate to their “historical norms”
If you believe these proposed changes will become law, gifting now makes much more sense than under current law (step up in basis at death and over $10 million estate and gift tax exemption).
These proposed changes might mean 50% tax on lifetime transfers of $1 million or more! Back in the 1990’s when the estate tax rates and exemptions were at “historical norms” we often encouraged clients with considerable wealth to make lifetime (before death) transfers to the next generation to affect what we called an “estate freeze”. The goal was to not only move the low Proposition 13 property tax bases down to the next generation utilizing the lifetime $1 million ($2 million for a married couple) exemption from reassessment, but to move appreciating assets out of estates that were growing over the estate and gift tax exemption.
This should be a call to action for families with highly appreciated California real estate assets with low assessed property values who intend to pass those properties down to the next generation.
One way that we used to affect these transfers back in the 1990’s when the estate tax exemption was “historical”, was the Family Limited Partnership (FLP).
Donor generation (DG) would set up an FLP. DG would gift undivided interests in the property being passed down to the donee generation. The donee generation members would contribute those undivided interests into the FLP. The DG would be the general partner (able to essentially control the FLP and the asset inside the partnership). The DG would put the general partner interest into their living trust thus control of the FLP passes in an orderly manner to the person or institution chosen to administer the assets of the estate.
Clients liked this approach because it retained the low property tax base (if the FLP was formed and funded correctly), retained control by DG and one or more significant appreciating assets were removed from a growing taxable estate and transferred to the next generation. If we are to lose step up in basis at death and the estate tax exemption is to be reduced significantly, this strategy will be quite attractive.
There are several effective strategies besides the FLP and they are all complicated. Interested parties will usually require the services of competent legal counsel with extensive knowledge in this area and guidance from their tax professional. Such strategies for transferring property that are beyond the scope of this article.
If you have highly appreciated property in California with a low property tax base and you want to transfer some of that wealth to the next generation without a reassessment for property taxes, this is your call to action! After February 15, 2021, transfers of most California real estate will result in reassessment at current market value. For assistance, or if you have questions about the impact on your family, please call our office.