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Proposition 19 Property Tax Changes Parent Child Exclusion

The recent passage of Proposition 19, together with its accelerated effective date, will have a dramatic impact on property tax planning for parents and children. Homeowners who wish to transfer their primary or vacation homes with a low taxable value to their children will no longer enjoy exclusion from property tax reassessment. (Proposition 19 uses the term ‘taxable value’ for what otherwise may be referred to as ‘assessed value’ or ‘base year value as adjusted.’)

Proposition 19 also eliminates the $1 million parent child exclusion from property tax reassessment on other real property transferred between generations. The proposition applies to transfers of real property occurring on or after Feb. 15, 2021.

Proposition 19 includes favorable revisions to the property tax reassessment rules that might reduce property tax reassessment for certain transfers. Proposition 19 allows certain homeowners to use their favorable property tax value from their original home to reduce the property tax value for a replacement home of greater value. Proposition 19 specifies that these provisions apply to transactions occurring on or after April 21, 2021.

Under pre-Proposition 19 law, children who receive the family home and other real property with up to $1 million of assessed value maintain their parents’ low tax base value. This benefit enabled substantial wealth to be transferred from the senior generation to the younger generation without adverse property tax consequence.

Proposition 19 limits the parent child exclusion to transfers of the family home when the child-recipient of the property makes the home the child’s primary residence. The child must claim the homeowner’s exemption within one year of the transfer. The exemption disappears for all other real property transfers between parents and children.

If the market value of the property at the time of the transfer exceeds the parent’s taxable value by more than $1 million, the child’s taxable value is the market value of the property less $1 million.

Under current law a transfer by the parent to a child of the family home with a taxable value of $100,000 and a market value of $2,000,000 would not change the property tax burden on the property. The transfer would be excluded from property tax reassessment. Under Proposition 19, the child’s tax base would increase to $1 million ($2 million minus $1 million), increasing the annual tax bill by a factor of 10.

The following category of clients should consider real property transfers before the effective date:

  • Clients with highly appreciated residential rental properties;
  • Clients with highly appreciated commercial properties;
  • Clients with highly appreciated industrial properties;
  • Clients who believe that their children will wish to retain the residence without using it as such; examples are vacation homes and homes in prime locations (e.g., waterfront properties, or desirable tourist destinations);
  • Clients with children who live in the family home and intend to remain after their parents’ death, or children who plan to move into the family home at their parents death, should consider how the value limitations of Proposition 19 will affect the resulting reassessment and whether their children could afford the new property tax payments.

Clients who meet these criteria might wish to transfer the real property to their children before Proposition 19 takes effect on February 15, 2021. The clients must balance the potential transfer and property tax benefits of lifetime gifts with the potential income tax consequences, taking into consideration the income tax basis adjustment rules of Internal Revenue Code §1014. Lifetime gifts may be the only way to preserve the taxable value of a property for property tax reassessment purposes, but the beneficiary of a lifetime gift receives the property with the same income tax basis it had in the hands of the donor (IRC 1015).

Proposition 19 does create benefits for certain taxpayers. Under pre-Proposition 19 law, homeowners over age 55 (or the severely disabled) can use the tax value from their original home for one transfer to a home of equal or lesser value, and only in or among certain counties. The replacement home can be existing or newly constructed in the same county, or can be located another county that has adopted an ordinance allowing base year value transfers from other counties, purchased within two years of the sale of the original home (Rev & Tax §69.5).

Proposition 19 expands this allowance in four ways: (1) qualifying transferors now include victims of wildfires and other natural disasters, (2) the base year value for the original home may now be used to reduce the taxable value of a replacement home of greater value than the original home (the taxable value of the replacement home is calculated by adding the difference between the full cash value of the original home and the full cash value of the replacement home to the taxable value of the original home), (3) the replacement home may be located in any county statewide and (4) a transferor may benefit from this reduction in assessed value for up to three subsequent transfers.

For example, a qualifying homeowner who owns a home with a taxable value of $500,000 with a market value of $1,000,000 would pay roughly $5,000 annually in property taxes. If the homeowner purchases a replacement house for $2 million, currently the homeowner would need to pay $20,000 annually in property taxes for the replacement home. Under Proposition 19, the assessed value of the replacement home would be $1,500,000 (($2 million-$1 million) + $500,000) and the homeowner would pay $15,000 annually for the replacement home.

The Dell Maneuver— taking advantage of legal entities

Proposition 19 does not amend any change of ownership rules for properties owned by legal entities, which generally provide that legal entity interests can be transferred from current owners to new owners without triggering a reassessment (the rules make no distinction among parents, children, and other third parties), subject only to the change of control rule and cumulative co-ownership rules. This legal entity rule is sometimes referred to as the “Dell Maneuver,” whereby Michael Dell purchased the Fairmont Miramar Hotel in Santa Monica without triggering a reassessment.

Setting aside the cumulative co-ownership rule, the change of control rule is relatively easy to bypass and thus, when structured correctly parents may transfer 100% of their legal entity interests (e.g., common stock, and LLC membership or partnership interests) to their children without triggering reassessment, much like the principal residence and other property exclusions previously discussed.

Now that Proposition 19 has become law, individual owners would therefore have an incentive to transfer their property to a legal entity to avoid future reassessment. Additionally, in light of Proposition 19, owners should consider whether it is preferable to transfer recently acquired property into an LLC right now, without claiming any exclusion and therefore resulting in a reassessment, to protect against future reassessment. The incremental increase in property value as a result of such reassessment should be modest (depending on how recent the property was acquired), and the benefit of relaxed legal entity change of ownership rules can be significant. It should be noted that there are regular attempts to close off the Dell Maneuver legislatively, but none have succeeded to date.

About the Author
D. Steven Yahnian has been a member of the California Bar and a practicing Attorney since 1980. He has also been a California CPA since 1984. Mr. Yahnian also holds the CFP® designation.

Mr. Yahnian practices in the following areas of law through YAHNIAN LAW CORPORATION:

  • Tax Planning, Tax Debt Resolution and Tax Litigation
  • Business & Corporate Law & Planning
  • Estate Planning & Administration
  • Real Property Law & Planning
  • Asset Protection Planning

As a CPA/CFP, Mr. Yahnian also has a separate accounting and tax return preparation practice called DSA ACCOUNTING.

Mr. Yahnian is a California State Bar Certified Specialist in the following
• Taxation Law and
• Estate Planning, Trust & Probate Law.

Mr. Yahnian received a B.S. degree in Accounting from USC, a J.D. from Loyola University of Los Angeles School of Law and an LL.M. in Taxation from New York University Law School. He also has a Certificate in Taxation from UCLA (with distinction).

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