Because of the high cost of homes in California, the old property tax rules made buying and selling a home challenging for some homeowners due to the impact that an increase in property tax payments would have on a family’s budget. The passage of Proposition 19: The Home Protection for Seniors, Severely Disabled, Families and Victims of Wildfire or Natural Disasters Act, hopes to relieve some of the increased financial burden as a result of moving to a more expensive home. However, Prop 19 offsets this tax savings with a tax increase to children who inherit a home. Here are three things you should know about this significant new law.
#1: Background on Proposition 19
One of the most significant purchases you will make in your lifetime is the purchase of your home. While you own your home, you will have to pay property taxes to the county where you live. The initial property tax rate that you pay is based on approximately 1% of your home’s assessed value and is increased 2% per year. (Keep in mind that the assessed value of your home is generally based on the purchase price but could be higher or lower depending on the “assessment” made by the county’s municipal property tax assessor.)
Now, if you purchased your home 20 years ago your annual property tax payments are probably pretty low compared to what new home owners would pay today. The average price of a home in the San Francisco Bay Area in the year 2000 was approximately $500,000 so annual property taxes were about $5,000. Today, that same home would cost approximately $1,600,000 and annual property taxes would be about $16,000. A difference of $11,000 per year!
The rising costs of homes in the Bay Area over the past 20 years has made the increase in property tax payments a major factor in deciding to buy another home. Prior to the passage of Proposition 19, you could potentially qualify for a one-time tax property tax break if you sold your home and purchased a new one. If you were at least 55 years old, purchased a home in the same county as your previous home, and the value of your new home was of equal or lesser value to your existing home, you would be allowed to transfer your original home’s assessed value to your new home and not incur an increase in property tax payments.
For example, suppose you purchased your original home in the year 2000 and the assessed value of the home is now $475,000. Your annual property tax payment would be about $4,750 today. If your original home was currently valued at $1 million and you bought a new home for $1 million, you could transfer your original home’s assessed value of $475,000 to your new home and incur no changes in annual property tax payments. (Note: A Second exemption is also granted to severely disabled persons over 55 years old).
However, statistics show that when people move, they often move to a new county. Secondly, most people will purchase 2 to 3 homes in their lifetimes. Thirdly, there was a good chance that the assessed value of your new home would be much more than your current home’s assessed value. Thus, prior to Prop 19, you were more likely to face an increase in your property taxes when you moved. As a result, you see more people holding on to their homes and passing it on to their children. The children would inherit the home with the same assessed value as their parents and thus, see no increase in their property taxes.
The old property tax law also created unintended negative consequences for people who tragically lost their homes to wildfires. They were forced to move into a new home against their will, face undue financial hardship, plus have the burden of having to pay higher property taxes on a more expensive home.
#2: Proposition 19 is a positive for older homeowners
With the passage of Prop 19, people who are either age 55 years or older, has a severe disability, or lost their home to a wildfire, may now blend the assessed value of their existing home to their new home and therefore realize significant property tax savings. Secondly, these same people can transfer the tax assessment three times in their lifetimes instead of just once. Thirdly, people can move anywhere in California and receive favorable property tax treatment. They don’t have to stay in their own county.
For example, suppose a retired couple in their early sixties, owns a home in San Francisco County with an assessed value of $800,000 and pays annual property tax payments of $8,000 per year. The current market value of their home is $1,200,000. They wish to sell their old home and buy a home in Los Angeles County worth $1,500,000. The assessed value of their new home will be calculated like this:
Assessed value of original home =
Difference in Value of New home & original home ($1,500,000 - $1,200,000) =
New Home Assessed Property Value =
This couples will save $4,000 a year in property taxes because instead of paying $15,000 in annual property taxes under the old rule, this couple would pay $11,000 a year.
#3: Proposition 19 is a negative for children who inherit homes
While Prop 19 can potentially help older homeowners save money on property taxes when moving into a new home, it increases property taxes on children who inherit their parents’ home. Under the old rule, if a child inherited their parents primary residence, there was no change in the assessed value of the home and the child could live in it or rent it out as they wished. For example, if a child inherits a home in San Francisco with an assessed property tax value of $500,000 but is now valued at $3,500,000, the child would incur no increase in property taxes and the annual property tax payment would remain at $5,000. (This is one of the major reasons why homes in high priced communities tended to stay within the family). If the child also inherited a second home which was other than a primary home (rental, vacation home, commercial property, etc.), the home was reassessed but up to $1 million was excluded from the reassessed value. For example, if the second home’s current fair market value is $1,350,000, then the reassessed property tax basis would be $350,000 ($1,350,000 - $1,000,000).
Beginning on February 16, 2021, a child who inherits a home and decides to use it as their primary residence, the home will be subject to a reassessment with $1 million being excluded from the property tax basis. Using the first example above, if an inherited home’s fair market value is $3,500,000, the reassessed property tax basis would be $2,500,000 ($3,500,000 - $1,000,000). The annual property tax payment would be about $25,000 under the new law versus $5,000 under the old law.
On the other hand, if the child chose not to live in the home and instead rents it out, the home would be considered “other than a primary home” and it would lose the $1 million exclusion and the inherited home’s assessed value would be the the full fair market value of $3,500,000. The annual property tax would increase to $35,000 versus $5,000 under the old law. As you can see, the annual property tax obligation would now be very significant regardless if the child lived in an inherited home or rented it out. Rather than keep the home, a more affordable option could be to sell it and avoid the high annual property tax payment.
To preserve the existing property tax breaks under the old rules, some people are transferring their properties into an irrevocable trust. Time is running out to do this, but If you wish to explore this option, please consult your Estate Planning attorney and your tax professional.
In summary, the winners of prop 19 are people over the age of 55, disabled people, and those impacted by wildfires in California. They can now move to a new home anywhere in California and know that they will not pay as much in property taxes as they would have under the old rules. However, the losers are children who inherit a home as they will certainly have to pay significantly more in property taxes. The biggest winners though will be the real estate industry as more people will be inclined to sell their homes under this new law.
This content is developed from sources believed to be providing accurate information, and provided by Attune Financial Planning. The opinions expressed and material provided are for general information only. Please consult your financial, tax, and estate planning professional regarding your specific situation.