CA Proposition 19 is a constitutional amendment that passed in November 2020. This Proposition significantly changed the way children inherit real property from their parents. As a result, some California residents have changed their estate plan in an attempt to mitigate the impact of Proposition 19 on their estate plan. However, there continues to be misunderstandings about exactly what changes Proposition 19 made to California law.
Prior to February 2021, children were able to inherit a primary residence of unlimited value from their parents without triggering a reassessment for property tax purposes. In this scenario, the children would be able to inherit the property and use it however they pleased. This included using the house as a second home, a rental, or a vacation home while continuing to pay property taxes based on the same formula as their parents did. In some areas, this could allow the children who inherited the home to save thousands of dollars in property taxes each year.
Under the new law, effective February 16, 2021, the children are now subject to stricter rules. First, they must maintain the property as their own primary residence. Under the new rules they cannot own the house as a second home, rental, or vacation home if they want to avoid a property tax reassessment. Second, there is a $1 million cap on the value of the home that can avoid reassessment, even if the child inheriting the home uses it as their primary residence.
This new law affects many families as the primary residence is often one of the largest asset’s parents may own and pass to their children at death. In addition, some families may have purchased their primary residence decades ago at much lower prices, as compared to the value today, allowing them to pay very low property taxes under the California Proposition 13 rules. Therefore, a reassessment could lead to a sharp increase in property taxes.
As a result, families are getting creative in thinking of ways to transfer assets to their children so that they may not be subject to the reassessment. Such strategies may include gifting real estate before the owner passes or more complex estate planning using Trusts to control how a property passes to the next generation. However, these decisions are sometimes made without looking at the bigger picture. For example, many of the strategies used to avoid an increase in real estate taxes may result in higher capital gains taxes down the road if the property is ever sold. This could be the equivalent to saving a small amount in property taxes each year only to pay even more in capital gains taxes in the future. Therefore, it is important to look at all aspects of a plan to weigh the pros and cons before making an irreversible election to avoid an increase in property taxes.
While we always encourage exploring other options, keep in mind it is important to first determine your long-term financial goals, including how you’d like to pass your assets to the next generation, and how your children plan to use the assets during their lifetimes. Sometimes doing nothing may be the best option. When in doubt, we generally advise that clients maintain the highest degree of flexibility within their financial plans as goals, objectives, circumstances, etc. often change.