Introduction
California’s Proposition 19, passed by voters in November 2020 and implemented on February 16, 2021, has redrawn the landscape of real estate taxation and inheritance. With these significant changes, estate planning strategies must evolve to encompass the new tax implications for inherited properties.
Before Prop 19: Property owners could pass their primary residences, and up to $1 million of other property, to their children (or grandchildren if both parents are deceased) without triggering a reassessment of the property’s value for tax purposes Cal. Const. art. XIII A, § 2.
The Mechanics of Proposition 19
Tax Base Transfer
Under Proposition 19, homeowners aged 55 or older, severely disabled, or victims of natural disasters are allowed to transfer their property tax base to a replacement residence up to three times California Board of Equalization.
Example:
Jane, a 57-year-old homeowner, decides to downsize. Thanks to Proposition 19, she can move from her family home in Silicon Valley to a smaller property in San Diego without experiencing a hike in her property tax, even though the market value of the new home is higher.
Before Prop 19:
- Parents could transfer primary residences to their children without a change in the property tax base. They could also transfer up to $1 million of assessed value in other properties, like vacation homes or rental properties.
After Prop 19:
- The property tax base can only be transferred if the child uses the inherited property as their primary residence, and there’s now a cap on the assessed value exclusion. Vacation homes or rental properties do not receive the basis transfer.
Inheritance Rules
The proposition modifies the rules around the inheritance of property tax bases California Legislature.
Implications for Estate Planning
1. Impact on Heirs
a) Increased Taxes:
Heirs inheriting properties that are not used as their primary residence or exceed the value exclusion cap will face higher property taxes, which could make inheriting and maintaining such properties financially unsustainable.
Example 1:
- Before Prop 19: Alex’s parents leave him a family home with an assessed value of $500,000. Regardless of whether Alex decides to live there, rents it out, or leaves it vacant, the property’s assessed value for tax purposes remains $500,000.
- After Prop 19: If Alex decides not to live in the inherited home, the property will be reassessed at its current market value, which could be significantly higher, leading to an increase in property taxes.
Example 2:
- Before Prop 19: Sarah inherits her parents’ primary residence and a vacation home with a combined assessed value of $1.5 million. Neither property’s assessed value is reassessed for property tax purposes.
- After Prop 19: Only the primary residence may be excluded from reassessment, and only if Sarah uses it as her own primary residence. The vacation home would be reassessed at current market value.
b) Selling Inherited Properties:
Given the new tax burdens, heirs may be compelled to sell inherited properties, a shift that could impact family legacies and long-term estate planning strategies.
Example:
Maria, who inherits her parents’ $2 million family home where the property tax is based on a $500,000 assessed value, will face a reassessment if she doesn’t move into the home. The increased property tax could make it financially challenging for Maria to keep the home, prompting a sale.
Implications for Estate Planning Strategies
a. Review and Update:
Individuals and families need to revisit their estate plans to accommodate these changes, especially those plans that include leaving homes to children.
b. Gifting Properties:
Some might consider gifting properties to their heirs before death to circumvent the new rules, though this comes with its own tax implications.
c. Trust Adjustments:
Estate planners will need to consider adjustments to trusts to optimize for the new tax landscape and minimize the financial impact on heirs.
Financial Planning Intersection
Wealth Management:
For wealthier individuals, the intersection of estate planning and financial planning becomes critical. The impact of Prop 19 may require diversifying assets or finding alternative methods to transfer wealth while minimizing tax impacts.
Real Estate Decisions
Downsizing:
Older adults might consider the implications of Prop 19 in their decisions to downsize or relocate, balancing the benefits of transferring their tax base with the limitations imposed on their heirs.
Adjusting Inheritance Strategies
Prop 19 limits the transfer of low property tax bases for inherited properties unless used as a primary residence by the heir, and even then, it is subject to a new value cap.
Example:
Mark inherited a property valued at $2 million from his parents. The original tax base was $500,000. Under Prop 19, if Mark does not use the property as his primary residence, the property will be reassessed at its current market value, leading to a significant increase in annual property taxes.
Navigating the Legal Terrain
Legal Citations
Prop 19 alters the application of sections 2.1 and 2.2 of Article XIII A of the California Constitution, impacting the reassessment rules of transferred property between parents and children or grandparents and grandchildren if the parents are deceased California Legislature.
Expert Consultation
The complexity of the proposition underscores the necessity of consulting with estate planning attorneys to revise and adapt existing plans, ensuring that they align with the new tax landscape while optimizing asset preservation and minimizing tax liabilities.
Conclusion
The implementation of Proposition 19 is a pivotal development with profound implications for real estate owners and heirs in California. It necessitates an in-depth review and, potentially, a comprehensive revision of estate plans to navigate the new tax implications effectively. Armed with informed insights and strategic adjustments, property owners can transition from reactive postures to proactive planning, turning the challenges of Proposition 19 into opportunities for optimized estate management and asset transitions.