Pros and Cons of California Prop 19
- Protects Property Rates for Certain Residents
- Makes Upgrading/Downgrading Easier
- Funds Needed Improvements
- Restricts Property Transfer Tax Rates
- Makes Retaining Inherited Property Difficult
- May Create a Middle-Class Exodus from the State
What is Prop 19 in California?
Prop 19 was a ballot measure introduced to voters for a statewide referendum in California’s November 3, 2020 election. California’s Proposition 19, or Assembly Constitutional Amendment No. 11 as it’s also called, was widely supported by the California Association of Realtors and other real estate agent associations, along with the California Professional Firefighters. Previous versions of the ballot measure failed to garner sufficient support in 2018 under the guise of Proposition 5, but in 2020 Prop 19 passed with a 51 percent vote.
What this means for California voters moving forward is property tax savings for older homeowners, more revenue for fire districts, and greater mobility for wildfire victims. However, this tax break will not apply to every homeowner, as it significantly modifies the parent-child exclusion that previously allowed a property owner inheriting property to retain the tax rate of their principal residence instead of triggering a new property tax rate during the transfer.
What is the Effective Date of Proposition 19?
Prop 19 went into effect on February 16, 2021. There has been a flurry of estate planning activity between Election Day (when it passed by a narrow margin of one percent) and the day it went into effect. Today, Prop 19 is in full effect, at least until new legislation is passed. Prop 19 was proposed to change California Prop 13 (which passed in 1978), so it is entirely possible that the law could be modified at a future date.
One of the most important components of Prop 13 was limiting California property tax to one percent of a property’s assessed value, setting assessed values at their 1976 value unless the home saw a change in ownership or additional construction. The law also capped the annual increase of the assessed tax value at two percent per year. This is a huge boon for California residents, where home values were subject to increase by as much as 10 percent per year, in contrast to the national average increase of around three percent.
What Were the Goals of California Prop 19?
As mentioned, the overall goal of Prop 19 was to provide more comprehensive tax benefits to certain groups of California residents, namely, those 55 and older, victims of wildfires and other natural disasters, and disabled homeowners. Prop 19 helps California residents falling into these categories with relocation. Whether it’s because of unforeseen circumstances—like one of California’s increasingly ubiquitous summer wildfires—or personal life transition, such as an older couple wanting to move into a smaller, more manageable home.
In return for these benefits, other homeowners could pay a price—namely, individuals who inherit a home. However, as we will see, there is a way around this issue for California residents who want to hold on to inherited property, and it’s a legal vehicle that should be used by most homeowners anyway, especially those with valuable property or multiple properties.
California Prop 19 Pros
Protects Property Rates for Certain Residents
As mentioned, property values in California generally see a strong increase from year to year. This can make moving difficult. But for certain residents, moving into a different home is a necessity. Individuals over the age of 55 often want or need to downsize their residence to a more manageable property. Ironically, even though the property might be smaller, the move might increase annual expenses, especially if the owner has resided in the same house for decades. This is because Prop 13 capped ad valorem growth at two percent per year, regardless of market values.
Previously, transferring ownership would trigger a reassessment, which means that an elderly couple moving into a smaller home could still be looking at a sizable adjustment to their annual property tax bill. Now that Prop 19 has passed, these residents can transfer their tax basis (that is, the value of the property used to calculate taxes) to any other residence in the state up to three times.
Makes Upgrading/Downgrading Easier
Senior residents in search of an easier home to manage are not the only ones looking to make moves within the Golden State. Upwardly mobile professionals in the last few decades of their working life often want to move into a nicer home. In many areas around the country, this is a reasonable financial venture, even if it makes their annual tax bill go up. But in California, the cost of real estate can make this type of upgrade cost prohibitive. This creates reduced mobility for homeowners who would like to move to a better neighborhood.
Prop 19 makes it easier for residents over the age of 55, disabled homeowners, and residents impacted by natural disasters to relocate because they can keep the ad valorem tax rate of their old property. And as mentioned, these types of individuals seeking a downgrade for financial or property management reasons receive the same type of benefit.
Funds Needed Improvements
Another winner with the passage of Prop 19 is the State of California itself, as well as the residents that benefit from its infrastructure. According to some estimates, the additional revenue collected from inherited properties will generate as much as $2 billion annually.
Proponents of Prop 19 state that these funds will assist in funding fire prevention, affordable housing, cleaner drinking water, and other community ventures. In regards to fire prevention, some California news publications argued that Prop 19 would bring much needed relief to suburban communities impacted by California’s wildfires, which according to some estimates have doubled since the 1980s.
Wildfire victims displaced by these events would have an easier time relocating and moving into new property within the state, so that they wouldn’t need to uproot their lives and move to a state with more affordable property tax rates.
California Prop 19 Cons
Restricts Property Transfer Tax Rates
Prior to the passage of California Prop 19, parents could transfer property to their children, and the transferred property would retain its tax basis despite the change in ownership. But now with Prop 19, inherited property used as a primary residence will be reassessed for its ad valorem tax basis.
A slight upside in the matter is that up to $1 million can be excluded from the property’s assessed value, but this isn’t much use to a resident inheriting a home with a property value less than seven figures. Moreover, residents inheriting homes with market values more than $1 million are likely to see a bigger tax bill. Additionally, the $1 million exclusion is only for an inherited primary residence. Rental properties, vacation homes, or investment properties are subject to this exclusion. They will be reassessed at their market value up ownership transfer, resulting in bigger tax bills.
Makes Retaining Inherited Property Difficult
As you can imagine, these changes will give inheritors of personal and rental property something to think about in terms of whether or not they want to or can afford to keep the property that has been bequeathed to them.
Since 2010, more than 650,000 Californians have inherited property in the Golden State. This property was an attractive asset because the two percent cap on ad valorem increases created a very low tax bill in comparison to the property value. In the case of rental properties, this meant collecting more rent and paying less taxes. In the case of personal property, this might have meant a family residence or a desirable vacation home that was affordable to hold on to for future generations.
Tangentially, supporters of Prop 19 argued that many California residents who obtained a home with the desirable tax breaks afforded by Prop 13 did not actually live in these homes, but rented them out. Most notorious among examples of this situation was that of actor Jeff Bridges (The Big Lebowski), who inherited a beachfront Malibu home from his parents with panoramic views of the Pacific Ocean. Bridges did not live in the residence, but rented it out for $15,000 a month.
May Create a Middle-Class Exodus from the State
Not all inherited property is a beachfront home in Malibu. Many homes were passed on from middle class homeowners to their children, providing them with homes in areas that would otherwise be impossible for them to move into, such as the San Francisco Bay Area.
These homeowners are now looking at an increased tax bill that makes remaining in their current location financially difficult. These residents may choose to sell their property and head to a more affordable part of the state, but as it turns out, property values in most areas of California are pretty steep. This makes nearby states like Colorado, Oregon, Arizona, and Nevada (to name a few) more attractive. One unintended side effect of Prop 19 may mean that middle class families start leaving the state in search of more affordable living, only time will tell.
Is Prop 19 Fair?
Interestingly, supporters of Prop 19 point to an inverse dilemma, where homeowners moving into a new property feel trapped after just a few years of living there. Their tax bill would be significantly higher than it was in their old home, and if it became untenable to continue paying, the value of their new property might make it difficult to sell.
Additionally, Prop 13 created a strange demographic situation where someone who had just purchased a $2 million home would be paying $20,000 in taxes, while a next-door neighbor living in a similarly priced home for decades is only paying $2,000 for the same local government services like road maintenance, schools, and trash collection. Supporters of Prop 19 point to the fact that it will make it easier for middle class families to move around within the state, while making taxpayer contributions more equitable.
Is Prop 19 Retroactive?
The good news is that Prop 19 is not retroactive. If you are residing in an inherited home, you can rest easy knowing that any homes transferred on February 15, 2021 or before will not be impacted by Prop 19. It is only on transferred property moving forward that Prop 19 will add to the already extant list of concerns around estate taxes. In regards to the ability of certain classes of residents to transfer their tax basis, that is also not retroactive.
Examples of Prop 19 at Work
Let’s say a couple in their late 50s lives in a home with an assessed value of $200k and wants to move closer to their grandchildren. The home they’ve found to facilitate such a relocation are priced at $800k. According to the old tax regulations, this would mean shifting from an annual tax bill of $2k to an annual tax bill of $8k—a 400 percent increase. To put things in perspective, that amount of cash might equal six annual vacation or a remodeled bathroom—it’s a sizable difference! More importantly, it’s an additional $500 per month for a couple entering a period of their life when they want to be on a fixed income.
Now, with Prop 19 in effect, this couple can transfer the tax basis of their $200k home to their new $800k one. Adding to that benefit is the fact that if this couple wanted to move two more times, in-state, for whatever reason, they could continue to carry that original tax basis with them.
One of the ideas behind Prop 19 is that now, in the above example, the elderly couple would have a similar tax bill as a neighbor who had lived in the neighborhood for decades. Proponents say the bill makes taxes more equitable, but what about a new neighbor (who doesn’t meet the requirements of Prop 19) that moves into a nearby $800k home and now faces a tax bill of $8k? Questions like these may be addressed in future ballot measures.
While Prop 19 certain has its benefits for certain types of eligible California residents, it can have drawbacks for others.
Consider a family who moved into a suburban home just outside of Los Angeles in the 1950s. As of 1976, the assessed value of the property was listed at $50k. Under the old tax laws, the tax base of that property would be set at the then-current fair market value of $50k with a two percent increase in its assessed value every year.
If this family gave the home to their children on February 15, 2021, they would be looking at a piece of property worth $95k. If, however, they gave their home to their children on February 16, 2021, it would be a different story.
Median home prices at the time of this article in Los Angeles County are roughly $700k. To keep our example simple, let’s use a one percent property tax rate. Property inherited before Prop 19 took effect would have a $950 annual tax bill. Property inherited after Prop 19 would have a $7k tax bill—a whooping 736 percent increase.
While our example was specifically drawn from a home in Los Angeles, a similar story is likely to play out in other areas of California. Median home prices in Sacramento hover around $400k, and the current median home price in San Francisco is around $1.625 million. As you can imagine, Prop 19 can make inheriting property unaffordable for some residents unless they work with their benefactor to transfer the property through a legal vehicle, like an irrevocable trust.
How is Property Held in a Trust Affected by Proposition 19?
You might be wondering if a land trust can be used for circumvent the trigger on a property value reassessment. As it turns out, the answer is yes and no.
Revocable trusts will not work to bypass the reassessment triggered by a transfer, but irrevocable trusts will. To keep an explanation of the differences brief, the terms of a revocable trust can be changed by the grantor, while an irrevocable trust requires permission from the beneficiary to make changes. Facilitating management of the asset in question is the trustee, who is often a lawyer familiar with California laws around land trust creation.
On the other hand, if you have assets (like property) that you want to keep in the family without suffering punitive estate taxes and transfer taxes, you should really be using a land trust anyway. Though Prop 19 may seem to create an unappealing situation in terms of bequeathing real property to your heirs, for some property owners, it might provide a much-needed impetus to create a better legal structure and tax strategy around the property they own.
Does Proposition 19 Apply to a Transfer of a Rental Home?
Yes, it does. Moreover, prior to Prop 19, up to $1 million could be excluded from the newly assessed value of a rental property. That benefit is now gone, and any property that is not the primary residence of the inheritor will be reassessed for an entirely new tax basis based on the current market value of the property.
As you can imagine, in some cases, this will result in a much steeper tax bill. Speaking to someone familiar with real estate asset management might provide you with ways to get around this issue, such as creating a corporation that is legally separate from the family and its personal assets.
Consult with a Financial Expert to Create a California Prop 19 Strategy
Prop 19 is here to stay, even if it just barely passed in the polls. While it may seem to make inheritance more difficult for California residents, these individuals should really be exploring the benefit of a land trust anyway, in order to protect their assets.
At the same time, Prop 19 will create greater flexibility for older residents to move to a more desirable location within the Golden State, since they won’t need to be afraid of an increased tax bill. Residents who lost their home in a California wildfire or other natural disaster will also have the opportunity to continue living in their communities.
Lastly, although most any tax advisor or lawyer familiar with the ins and outs of real estate taxes would be able to advise on the benefits of using a trust, those who don’t leverage this type of vehicle may provide the state with additional tax revenue that will hopefully be allocated towards disaster and wildfire response, a measure that will ultimately benefit all homeowners who choose to reside in California.
Free Strategy Session with an Anderson Advisor
Receive a detailed risk assessment to assist in lowering problem areas that could wipe out all of your assets with one wrong move. Speak with an Anderson Professional Advisor to get your FREE Strategy Session. Limited-Time offer: FREE (a $750 value.)