As discussed in the previous columns, Proposition 19 has arrived like a Trojan horse.
When California citizens let the horse in Prop. 19, they believed they would allow homeowners 55 and older, the disabled, or victims of disaster to transfer their property tax base from one home to another across California.
Many were shocked to learn that a law was passed in the belly of this wooden horse preventing parents under any circumstances from giving their property to their children without reassessing property tax.
What can you do before February 16, 2021 to keep the horse out of your living room?
Every decision you make requires an analysis of property, income, and estate taxes. Unfortunately there are no easy answers.
Option 1: Transfer ownership now
A) If a deed transfer is completed before February 16, then it is a change of ownership qualifying under applicable law for parent and child exemption from property tax revaluation. (Note that the assessor's offices will be closed February 12-16, so the actual deadline will be February 11th.)
B) This is a gift.
C) You must file a gift tax return and apply for part of your inheritance / gift tax exemption. This requires an assessment of the value of the property at the time of the gift. The valuation must take place at the time the gift tax return is submitted (April 15, 2022).
D) You cannot take the property tax base of your transferred home with you into your next home.
Related Prop. 19 Links
How transfers of ownership to children change will change on February 16
State offers guidance on new property tax transfer law
California's Prop. 19: Important things the new property tax law gives and takes away
E) If it is your home that you have moved, you will have to pay rent to your children if you stay in the house (although there may be workarounds). They can drive you away.
F) If it is a rental property, the rental income will now go to your children.
G) Your children own the property and are therefore subject to the claims of their creditors. You also need to be insured and pay property taxes.
H) Your children will not receive an increase in the income tax base on your death. This can be important.
This last part is important. What a difference that makes:
For example, suppose Polly bought her house for $ 100,000 decades ago. It's now worth $ 1 million. Now, if Polly transfers her home to her three children, her income tax base on the property will be $ 100,000.
Maggie bought the house next door for the same price and it's the same value. But Maggie doesn't bring her home until she dies. Their children have an income tax base of $ 1 million.
If Polly's children sell Polly's house immediately, they will have taxable profit of $ 900,000 (the sale price of $ 1 million minus their gifted income tax base of $ 100,000). You will face federal income tax of approximately $ 333,000.
If Maggie's children sell their home, they will have no taxable profit ($ 1 million sales price minus $ 1 million increased income tax base). They will have $ 333,000 more than Polly's children.
Polly's kids won't bother with property taxes since they'll be selling the house anyway, but they're sure to get upset about income taxes. If the children don't sell the house, they may be happier if the property tax base is transferred.
Option 2: sell the property to your children
A) A sale of property to your child for a promissory note is a change of ownership for property tax purposes and the current parent and child exemption is in place to avoid property tax revaluation.
B) You can give the note over time ($ 15,000 per parent per child per year) with no gift tax impact. In the event of your death, any remaining balance may be passed away with no estate tax implications if your estate is under inheritance tax exemption (currently $ 11.7 million per person).
C) You sold the property so you are recording taxable profits for income tax purposes.
D) Property appraisal is done outside of your estate, which is good if you have a potentially taxable estate.
E) Your child's income tax base is the selling price.
F) You have the same problems as D-G in option 1.
Option 3: Transfer ownership to an irrevocable trust
A) A transfer to an irrevocable trust for the sole benefit of your children is a change of ownership that would allow use of the current parent-child exclusion from re-evaluation.
B) Your revocable living trust is not qualified as the transfer of ownership will not occur until after your death (presumably after February 16).
C) The irrevocable trust can be designed so that parent-child exclusion from property tax revaluation can be applied without meeting the estate and gift tax requirements for a completed gift. This means that for these purposes you will still "own" the property when you die. Therefore, she is subject to inheritance tax and then receives an increase in the income tax base. This is a win from a wealth and income tax perspective, but can be a problem if you have a taxable estate.
D) Alternatively, if you have a taxable estate, the trust can be designed to complete the gift and get the property out of your estate, but your heirs will not receive an increase in the income tax base. (If they still want to keep the property, that's less of a concern.)
E) The same rental problem applies to your primary residence, but your children's creditors are not a problem.
F) You cannot carry over the base year property tax value to your new home, but the trust could sell the current home and you would have a federal tax exemption of $ 250,000 per person on a primary home sale.
Option 4: The use of entities
For transfers of real estate other than a primary residence, use of a company such as a limited partnership should be considered. For example, a parent could transfer 51% of property with an estimated property tax value of less than $ 1 million to the children using parent-child exclusion. The children and the parent then form a unit, with the parent owning 49% and the child 51%, without the need for a revaluation of the property tax. If the parent dies, the 49% interest carried over will retain the increased income tax base, but will not result in a revaluation of the property tax.
Decisions decisions
There are variations and combinations of options 2 through 4 that are more technical and can be covered here. In addition, it is important to know that laws change. Inheritance tax exemption is currently $ 11.7 million per person, but will decrease to $ 5 million (adjusted for inflation) in 2026, and decrease to $ 3.5 million as proposed by President Biden. In addition, the base increase under Biden's Plan would be eliminated. Efforts could continue to be made in the future to send the Prop 19 Trojan horse back to pasture.
California property owners concerned about the effects of Prop 19 should seek help from a legal counsel. This article is provided for informational purposes only and should not be construed as legal advice or an opinion on any particular fact or circumstance. You should not act or fail to act on this information without seeking professional advice.
To update
The State Board of Equalization announced at its meeting on January 14th that it would propose legislation to clarify the following points:
–For the exclusion of parents and children after February 15, transfers to multiple children only require that one child make the transferred home their primary residence. Once that child moves out, the exclusion will cease to apply and a reassessment will be made unless another child makes the house their primary residence.
–A “family farm” does not need to be resident to qualify, and the $ 1 million value limit is per farm unit, not per parcel.
–The legislation is proposed to clarify the Parent-Child Exclusion Act under Prop. 19 in the hope that further guidance will be available by the end of January. The BOE is not authorized to extend the effective date of Prop. 19.
Teresa J. Rhyne is an estate planning and fiduciary attorney based in Riverside and Paso Robles. You can reach her at [email protected]