Proposition 19 Tax Alert: Take Advantage of the Parent-Child Exclusion While it Lasts
It looks like Proposition 19 has passed by a narrow margin of 51.5% to 48.5%, making it the first successful attack on the parent-child exclusion (Proposition 58) since passage in 1986. Under the soon to be old law, California real estate is exempt from reassessment for two types of transfers between parent and child (and, sometimes, grandparent and grandchild): (i) transfers of a parent’s primary residence to a child (or children) and (ii) transfers of up to $1 million of assessed (roll value) of a parent’s other real property to a child. Proposition 19 limits the exemption available for (i) and eliminates it entirely for (ii).
Under the new law, transfers of the primary residence from parent to child will be exempt subject to two limitations. First, the child must move into the primary residence and make it their own within 1 year of the parent’s date of death. Second, the County Assessor will determine the fair market value of the real property at the parent’s date of death and “cap” the reassessment exemption at a $1m difference in value between fair market value and roll value. For example, if Mom’s home is worth $2,000,000 at her date of death and the assessor’s roll value of the home is $500,000, there is a $1,500,000 difference in value between fair market value and roll value. Under this new law, if the home is transferred to a child, it will be granted partial exemption from reassessment and the assessed roll value will be increased to $1,000,000 (FMV less $1m).
As part of the new law, seniors will be able to transfer their real property tax basis to properties throughout California. Under prior law, seniors had a very limited ability to transfer their real property tax basis. Although it will limit tax dollars from seniors that are forced to relocate, this new law is projected to generate hundred of millions in real estate tax revenue for local governments, state firefighting, and other uses, by reassessing inherited property on a much more frequent basis. Proposition 19 was driven and funded by California realtors who will no doubt benefit from more frequent transactions by seniors and children who have inherited property subject to reassessment.
As a tax attorney, I’m already thinking up some major loopholes. For one, the law doesn’t apply to transactions occurring before February 15, 2021. While it is generally beneficial to hold real property until death in order to get the “step up” in income tax basis at death under IRC section 1014, there is no guarantee that the “step up” granted under Federal tax law won’t also be nixed in coming years. And, while the step up allows for greater depreciation deductions, it isn’t otherwise helpful for the child that never plans on selling the property anyway. For those that loath the idea of giving such valuable assets to their children during their lifetime, or want to maintain control, the real property can be transferred to an irrevocable trust structured to keep the parent in charge while creating a completed gift prior to the above deadline.
Lastly, the new law will further incentivize parents to take title to investment property with LLCs. Under the rules applicable to entities, when the entity takes title in a transaction that is not an exempt proportional interest transfer, the “change in control” rule applies and the real property will not be assessed until one party gains more than 50% or more control of the entity. So long as the parent has more than one descendant, the investment property could pass from generation to generation without ever being reassessed.
Please call 805.284.0711 or email email@example.com if you’d like to discuss planning opportunities available to you prior to the February 15, 2021 deadline.