Summary of Relevant Provisions of Proposition 19

California recently approved Proposition 19, which, effective February 16, 2021, (1) eliminates the $1 million parent-child and grandparent-grandchild exclusion for transfers of real property other than a primary residence; and (2) modifies the manner in which the taxable value of a primary residence is calculated following transfer.

Elimination of $1 Million Exclusion for Non-Principal Residence.

Under current law, each individual may transfer to his or her children (and in some cases grandchildren), during lifetime or at death, without causing any reassessment for property tax purposes, non-principal residence real properties with a total combined property tax value of $1.0 million. For example, each parent could now transfer multiple rental real properties with a total combined property tax value of $1.0 million without reassessment of those properties, even if the total fair market value of those properties was significantly more.

Note that this $1 million exclusion is for the assessed property tax value of the real properties, not the fair market value of the real properties.

For transfers after February 16, 2021, Proposition 19 eliminates this exclusion in its entirety.

Reassessment of Principal Residence.

Proposition 19 further modifies the manner in which the taxable value (or “tax basis”) of a primary residence is calculated following transfer. There are two primary portions of this section:

1. Limitation of Reassessment for Replacement Residence.     

A limitation on property tax reassessment for those (i) 55 years in age or over; (ii) severely disabled; or (iii) a victim of wildfire or natural disasters. An individual can take advantage of this limitation no more than three times upon valid application to the county assessor’s office.

  • (a) Replacement Residence of Equal or Lesser Value:

If any of such individuals replace their primary residence with another residence of equal or lesser value, upon application, the taxable value of the replacement residence will equal the taxable value of the original residence.

  • (b) Replacement Residence of Greater Value.

If any of such individuals replace their primary residence with another residence of greater value, then the taxable value of the replacement residence will equal the taxable value of the original plus the difference between the full cash value of the replacement and the full cash value of the original.

By way of example, let’s assume an individual over the age of 55 has a home (the “original residence”) with a taxable value of $400,000 and a cash value of $1,200,000. She sells the original residence, and purchases a replacement residence with a cash value of $1,500,000.

  • In this case, the buyer’s taxable value in the replacement residence will be:
    • $400,000 + [$1,500,000 - $1,200,000] = $700,000

2. A Change In The Methodology Of Calculating Property Tax Reassessment For A Primary Residence:

Proposition 19 created an expansion on property tax reassessment for a transfer or sale of a “family home” to children (or, in certain instances, grandchildren). Notwithstanding the provisions discussed above (regarding transfers by those older than 55, disabled, or affected by wildfires or natural disasters), any transfer of a primary residence to one’s child will be governed by the following property tax assessment rules.

For purposes of this section of Proposition 19, the term “Assessed Value” means the appraised value of the family home as of the date of transfer – in other words, the fair market value on the date of transfer. (Note: the use of the term “assessed value” in the Prop 19 legislation has confused many, since generally the term “assessed value” does not refer to fair market value.)

The term “Old Taxable Value” means the taxable value of the family home as of the date immediately prior to the date of transfer – in other words, the transferor’s property tax base.

(*the term “Old Taxable Value” is the author’s term – it is not used directly in the text of the proposed law).

The term “New Taxable Value” means the taxable value that the transferee has in the residence after the transfer is complete.

  • (a) Child Does Not Live in Family Home.

If the child does not live in the family home after transfer, the New Taxable Value will be the Assessed Value (in other words, the property will be completely reassessed for property tax purposes.

  • (b) Child Continues to Live in Family Home.

If the child continues to live in the family home as his or her primary residence, then the property will be reassessed as set forth below. Relevantly, beginning February 23, 2023, the $1,000,000 sum described below will be adjusted each year for changes in the House Price Index for California. (*Note: it remains unclear how the following provisions will function where more than one child is inheriting the family home).

  • If the Assessed Value is less than the Old Taxable Value plus $1,000,000, then the New Taxable Value equals the Old Taxable Value.

In other words,

  • If:  Assessed Value < (Old Taxable Value + $1,000,000)
  • Then: New Taxable Value = Old Taxable Value

By way of example, let’s assume an individual has a primary residence with a taxable value of $400,000. She decides she wants to transfer the residence to her child (whether by gift, sale, or otherwise). The appraised value of the primary residence as of the date of transfer is $1,200,000.

  • In this case, the Old Taxable Value = $400,000
  • The “Assessed Value” = $1,200,000

Because the Assessed Value of $1,200,000 is less than the sum of the Old Taxable Value plus $1,000,000 (which, in this case, equals $1,400,000), the New Taxable Value equals the Old Taxable Value of $400,000.

  • If the Assessed Value is greater than or equal to the Old Taxable Value plus $1,000,000, then the New Taxable Value will be the Old Taxable Value plus the Assessed Value reduced by the sum of the Old Taxable Value and $1,000,000.

In other words:

  • If: Assessed Value > (Old Taxable Value + $1,000,000)
  • Then: New Taxable Value = Old Taxable Value + [Assessed Value – (Old Taxable Value + $1,000,000)]

Let’s assume the same facts as above. An individual has a primary residence with a taxable value of $400,000. She decides she wants to transfer the residence to her child (whether by gift, sale, or otherwise). However, in this case, the appraised value of the primary residence as of the date of transfer is $1,500,000.

  • In this case, the Old Taxable Value = $400,000
  • The “Assessed Value” = $1,500,000

Because the Assessed Value of $1,500,000 is greater than the sum of Old Taxable Value plus $1,000,000 (which, in this case, equals $1,400,000), the New Taxable Value will be calculated as follows:

  • $400,000 + [$1,500,000 – ($400,000 + $1,000,0000] = $500,000
  • The New Taxable Value = $500,000      

Now let’s consider a more extreme example. Assume the same facts, yet again. An individual has a primary residence with a taxable value of $400,000. She decides she wants to transfer the residence to her child (whether by gift, sale, or otherwise). However, in this case, the appraised value of the primary residence as of the date of transfer is $2,500,000.

  • In this case, the Old Taxable Value = $400,000
  • The “Assessed Value” = $2,500,000

Because the Assessed Value of $2,500,000 is greater than the sum of Old Taxable Value plus $1,000,000 (which, in this case, equals $1,400,000), the New Taxable Value will be calculated as follows:

  • $400,000 + [$2,500,000 – ($400,000 + $1,000,0000] = $1,500,000
  • The New Taxable Value = $1,500,000

As our last example most clearly demonstrates, the impact Proposition 19 will have on transfers of family residences to children has the potential to be massive for certain clients – specifically, those who have owned their homes for a long period of time, have low property tax bases in such homes, and hope to pass such homes to their children. Under new Proposition 19, many children will be unable to keep the home transferred to them by a parent, simply because the property taxes will be unaffordable. Proposition 19 will likely lead to an increase in sales of low-basis, high-value residences inherited by children which, before Proposition 19, might have been retained by the children for investment purposes.

HOWEVER, the provisions of Proposition 19 only apply to transfers made on or after February 16, 2021. That means that there is still time remaining to make a transfer of a family home before being subjected to the more onerous property tax reassessment provisions of Proposition 19. Clients who intend for their child or children to inherit their primary residence may want to consider making a transfer during life, prior to February 16, 2021, rather than waiting until death, in order to avoid the potential increase in property taxes associated with Proposition 19.

On the other hand, a client who transfers real properties now in order to avoid property tax reassessment may risk losing the step-up in income tax basis that that those real properties would otherwise receive if transferred at the client’s death. While it is unclear whether or not such a step-up will be eliminated under the new administration, clients need to carefully weigh the potential benefit of current transfers against the potential of receiving a step-up in income tax basis for transfers at death.

Clients should carefully consider the scenarios presented in this memorandum, and reach out as soon as possible to ensure their estate plans are in order, particularly considering the time sensitive nature of many available planning options.

This update is provided to our clients, business associates and friends for informational purposes only. Legal advice should be based on your specific situation and provided by a qualified attorney.