Wednesday, December 16, 2020 / by Dave Salzman
In the wildly successful Netflix series, The Queen’s Gambit, Beth Harmon envisions her chess moves well in advance. It is her talent and leads to her success. What does this have to do with Proposition 19? Like Beth, you should practice your moves before acting. Do not be tempted to move too quickly or erratically just to beat the upcoming deadlines.
Before you start, let us review the new rules, the potential moves, and the timing.
Proposition 19 is essentially Two Different Sets of Rules combined into one new law, which are both related to property tax but are independent of each other:
1. Transfer of Tax Basis for Seniors (age 55+), severely disabled, or wildfire and natural disaster victims.
a. This one is a WIN for Seniors, Severely Disabled and Victims of Wildfires and Natural Disasters
b. Effective Date – April 1, 2021
c. What are the improvements over the old Proposition 60/90?
i. You can sell your current home and take your current property tax basis with you to a new residence ANYWHERE in the State of California.
ii. You can do this up to three-times in your lifetime.
iii. You can buy a more expensive home than the one you sell, but if you do, your new property tax basis will be a blended rate of your current property tax basis + the difference between the value of the property sold and the new, higher value.
WARNING: You must apply for this exemption. It is not automatic and the transfer to the new home must be done within 2 years of the transfer date.
The moves. Should you wait to sell until this law becomes effective on April 1, 2021?
Some analysts say wait to sell until on or after April 1st. You will ensure that you are within the statutory effective date, you will have access to the 3x transfer option, and you will be able to purchase a higher price property if you so choose. The CA Board of Equalization has issued guidance as follows: “...the operative requirement is that the transfer of the base year value must be on or after April 1, 2021, and not the purchase or sale of either the original or replacement property.” [i] The BOE notes also indicate that the Counsel Memos are “initial insights” and are subject to change. Therefore, you will need to discuss the interpretation and risks with your advisors.
2. Transfers between Parent/Child (Prop. 58) and Grandparent/Grandchild Transfers (Prop. 193) Modifications due to Proposition 19. [Simply “Child” for this Discussion]
a. This section of the new law is a LOSE for those who planned on passing their low property tax basis residence or 1 million in assessed value worth of other real property to their children. The WIN is for the programs that are benefiting from the increased property taxes to fund the measure.
b. Effective Date – February 16, 2021 [Note Feb calendar – February 15 is a holiday]
c. Parents/Children and Grandparents/Grandchild can only use the property tax transfer exemption for the “family home” if the recipient lives in the property as their own personal residence. Use of the purchased, gifted or inherited property for any use other than a personal residence ends the transfer benefit and the base year value is recalculated based on the amount that would have applied if the parent-child exclusion had not been applied.
d. Also, the recipient only gets the full benefit of the exemption if the market value of the home transferred does not exceed the tax basis transferred plus $1m. If the value exceeds that amount, then the recipient pays property tax based on the blended rate.
i. Example 1: Parents gift their personal residence to their child. At the time of the gift, the property tax value is $500,000. The market value is $1.5m. The child can keep the low tax basis of $500,000 (subsequently increased annually) because a $500,000 tax basis + $1,000,000 in value = $1,500,000 and meets the exemption test.
ii. Example 2: Parents gift their personal residence to their child. At the time of the gift, the property tax value is $500,000 and the market value is $2,000,000. [$500,000 + $1,000,000 = $1,500,000 but the market value is $2,000,000 so the property tax is the OLD rate based on $500,000 + a new applied tax rate to another $500,000 so it is a blended property tax because the market value exceeds the property tax basis rate at transfer plus $1,000,000.
e. There is a complete elimination of any other property tax basis transfers. Prop. 58/193 provided that each parent could gift/bequeath property OTHER than a personal residence up to $1,000,000 of assessed value per parent [e.g., Commercial building, apartment building, vacation property etc.] This is now gone.
f. File a Homeowners Exemption and establish residency within one year of the transfer.
So, the bottom-line rules on the property tax basis transfer to under Prop. 19, the child transferee must make the inherited/gifted property their personal residence and the benefit has a $1,000,000 cap over the property tax value at the time of the gift.
What are your moves BEFORE the February 16, 2021 deadline on the existing property tax transfers and AFTER the April 1, 2021 moves if you are over 55, severely disabled or a victim of wildfire or natural disaster?
If you are over 55 and want to move - since the new law is not effective until April 1, 2021, the safest move is to NOT make the transfer until after April of 2021.
If you are a Parent or Grandparent and plan on gifting before February 16th, you need to understand the practical and estate planning consequences of the gift, the tax impact it will have on the recipient of the gift because the recipient receives that parents’ tax basis in the property for capital gains rules and the tax to be paid on those capital gains in the future if the property is sold. We also suggest reviewing the Biden Administration proposals regarding estate tax exemption limits, capital gain tax increases and potential elimination of the step-up in basis upon death. Each of these are factors that will need to be played out in various scenarios.
There are multiple options to consider that touch on estate planning, taxation, highest and best use of the property, value of the property to be transferred and use by the beneficiary or transferee. The tax consequences are critical, and the chess moves must be played, but get the chess board out now, as the opportunity to transfer parent to child under the existing rules ends February 15, 2021.
As for the move of the property tax basis by someone over 55+, severely disabled or wildfire or other disaster victim, the future is brighter after April 1, 2021, but delays may have other lifestyle and/or sale consequences. Play out all the moves, then decide!