Proposition 19 Explained, with Ryan Lockhart
Heard about the major change the Proposition 19 is going to make? Curious how the Proposition affects the parent-child transfer of real property? Then I got you covered. In this solo episode of I Know a Lawyer, I go over the basic framework of Proposition 19 and how it will affect parent-child property tax transfers. In the episode, I discuss:
Current Prop 58 law basics and transfers of property other than the primary residence (01:49)
Prop 19 effective date and how it will eliminate exemptions for transfer of non-primary residences (04:50)
Two prongs of Prop 19 and requirements (06:50)
Example of transfer of home and partial reassessment upon transfer (08:38)
Other tax considerations before jumping to transfer before deadline (10:35)
Other possible solutions (13:12)
Find a handy chart from the Board of Equalization regarding the change here.
If you have a questions about Prop 19 or whether you should transfer your property prior to February 16, 2021, contact me at 925-433-5447, ryan@mckennabrink.com or reach us through our website at mckennabrink.com.
This podcast is for educational purposes. Don't take legal advice from a podcast, contact a lawyer instead for advice tailored to your situation.
Transcript
Ryan Lockhart (00:00):
Hello, everybody. Welcome to, I Know a Lawyer, I'm your host, Ryan Lockhart, and today's going to be a special solo edition of I know a lawyer because today I wanted to talk to about Prop 19 or Proposition 19 that was just passed in the November election. I think this is a good follow up to my earlier episode, where I did a solo on California property taxes. So if you haven't heard that episode go and listen to it, check it out. It'll give you a good basic foundation on California property taxes, how the system works and some key terms, especially the factored base, your value, or as I'm going to say again, today is your property tax basis. Before I jump into that, as you know, this, this podcast of, I Know a Lawyer is brought to you by McKenna Brink Signorotti, LLP. We are a boutique law firm located in Walnut Creek, check us out at mckennabrink.com.
Ryan Lockhart (00:54):
And you can see all the different areas of law that we cover areas of law ranging from tax and estate planning. What I do, to business transactional law or civil litigation, again, check us out at mckennabrink.com, where you can also find all episodes of the podcast. And you can also find all episodes of the podcast on your podcast apps, which is probably how you're listening to this today. All right. So let's talk a little bit about Proposition 19. It's a hot button topic. Received a lot of calls about this over the last couple of weeks, and I think it pretty much caught a lot of people off guard. So it seems like people didn't, or at least the advertising or about Prop 19 really only focused on the first part. And so there was two prongs to Proposition 19. The first prong dealt with, if you're over 55 and you wanted to move to a different part of the state, then you can transfer your property tax bases with you.
Ryan Lockhart (01:49):
And that made sense. It also included some wildfire victims, et cetera. And I think that's the part that people really wanted to vote on, but it had this second component where it substantially affected parent to child transfers. So to understand parent to child transfers, let's go back and talk about how the law is today. So there's this other proposition that's been in place for a long time called Prop 58. This is the current law for parent to child transfers. There's an exemption under Prop 58, where a parent or parents can transfer real property to their children and ex exempt that transfer from a property tax reassessment. And if you'll recall from the property tax episode, a reassessment is where the County will get to come in and reassess the property taxes based on the fair market value as the date of transfer. Obviously the County wants to do this and, you know, because especially if people have been holding property for a long period of time, they're paying lower property tax bills, then they could be paying if the County was able to reassess it.
Ryan Lockhart (02:54):
So under Prop 58, there was two exemptions nested underneath that proposition. And I've used this a lot in my practice. We actually planned for this quite a bit. The first one is parents can transfer their primary residence to their children. And once they, as long as they went parent to child or parents to children, then it was fully exempted. It didn't matter how much the property was worth. Didn't matter how low the parents' property tax basis in the property was worth. And there was no other requirements on the children to do anything with the property whatsoever. So it was a pretty easy exemption to take advantage of. And quite frankly, could save the children quite a bit in property taxes, especially if mom and dad had owned that home for a long period of time. The other exemption that Prop 58 provides is parents can transfer other property.
Ryan Lockhart (03:47):
So other property think of vacation homes, rental properties, commercial properties, anything that's other than their primary residence. And for that type of transfer, mom and dad each had a million dollar exemption toward that. So they could transfer a million dollars each of their property tax basis in these other properties. It's not the fair market value, it's their property tax basis in these other properties. Quick example, mom and dad own a rental residential property and maybe a commercial building as well, but they bought that the rental property, the residential one a long time ago, and they bought it for $500,000. Well, that's their property tax basis in that property. So they could transfer that rental to their children. And they would only use $250,000 each of their collective $2 million exemption for these other properties. So effectively they could transfer that whole rental property to the children, completely exempt it from a property tax reassessment.
Ryan Lockhart (04:50):
It's a nice planning tool and it's a nice benefit to the children too. So in sometimes we would even look, if they had multiple properties, like a pretty large real estate portfolio, we would kind of do an analysis where we'd look at, okay, which properties has the lowest property tax basis? Where can we get the biggest bang for our buck on these, on this extra $2 million of exemption that we can use. So it's a nice planning tool, again, that we can transfer a lot of real property to the children without triggering a property tax reassessment. So those are the rules that are under Prop 58, which Prop 58 is still in effect today. When I say today, I'm talking December 10th, 2020, the day that I'm recording this, because now we have Prop 19 coming down the road here and quite soon.
Ryan Lockhart (05:36):
So Prop 19 or Proposition 19 was passed in November and it is going to be effective February 16th, 2021. So any transfer of property between parents and children prior to February 16th will still fall under the Prop 58 rules, but any transfer that is effective February 16th, 2021 or later will fall under the new Prop 19 rules. So what did Prop 19 do? Well, in addition to doing that, what I said in the beginning was that first part where if you're over 55 and transferring on state, you can don't have to pay a new property tax bill. That's fine. But the other part is it's substantially really substantially changed the parent, a child transfer. So now under Prop 19, there's really only one way to get the exemption Prop 19 looked at that, that $1 million of other property that each person had to exempt and just completely removed it. So now Prop 19 only looks at the primary residence of mom and dad added to a two prong test or two-pronged requirement to that type of transfer.
Ryan Lockhart (06:50):
So mom and dad can still transfer their primary residence to a child or children, but there's two subsequent requirements that are going to happen. One is the child or children have to make the, that residence, their own primary residence. How's this going to work when you have more than one child? Well, that remains to be seen. We are waiting on some guidance that is going to come from probably the board of equalization where they'll expand some guidance to say how they're going to treat these types of situations, where a prime mom and dad's primary residence are transferred to multiple children. And let's say one of the children does agree to live in the home and make it their own residence. Does that mean we get the full exemption because one of the children did it. We don't know yet. It could be a possibility where the state may say, well, the share that's allocated to the child who does move into the home will be exempted.
Ryan Lockhart (07:45):
But the share of the home that was allocated to a different child who does not live in the home may not be exempted. So there's some open-ended questions. And once that guidance does come down, I'll most likely make another episode about this to keep everybody up to date, because this is definitely, like I said, a hot button topic in my world right now. There is that second requirement that I mentioned. The second requirement is the County or Prop 19 is only going to allow the exemption for a total of $1 million over mom and dad's property tax basis. So let's use a quick example with numbers to illustrate mom and dad bought the home, their boat. They bought their home for $500,000 at the time of transfer. Usually when mom and dad died, let's say the home value was $2 million. Well, Prop 19 said, okay, we get an extra million on top of mom and dad's property tax basis.
Ryan Lockhart (08:38):
So that would be 500,000 plus a million. So 1.5 million, but the property is worth $2 million. So that means that the County is going to be able to reassess the difference between the 1.5 million and the two main dollar fair market value. So that $500,000 difference will be reassessed. So even if we have this transfer from parent to child and the child agrees to make that residence, their own primary residence, they're still gonna get hit with a reassessment for that difference of the $500,000 that may end up proving to be a cost prohibited, move for them, because that increase in property taxes, which is an, you know, increases those, that portion of the property taxes every year, right? That may, may prove that this is too expensive for them live in that home. So I think there's going to be a lot of unintended consequences to Prop 19, especially when you're talking about multiple children are involved and how that's going to work, but also about, you know, this reassessment above this $1 million plus the property tax basis threshold.
Ryan Lockhart (09:43):
I just don't think people really understood that this is what it was going to do, and I can see I've already not, not only do I see I'm hearing from clients that they're quite frankly a little surprised by this, and then a little upset that they don't think this was the intended consequences behind the proposition at all. And we'll see how long this even lasts. I mean, obviously these propositions can be changed in the future if there's a new proposition to modify it. But I don't know if that, I don't know when that would happen. All we can do is plan for what is about to happen. Like I said, Prop 19 comes in on February 16th, which leaves us about two months. If the parents do you want to try to look at making a transfer prior to February 16th, but I will caution everybody just because this law change is going to happen February 16th does not mean everybody should start transferring property to children.
Ryan Lockhart (10:35):
Each case is different and there needs to be a pretty comprehensive analysis. That's going to look at what is the benefit of doing this type of transfer before February 16th? So what is a property tax savings actually going to be because there are some other tax implications that should be analyzed. One of those is the step up in tax basis. So one tax effect of dying, so to speak is a property in the decedent's estate gets a step up in tax basis. So this is, is an income tax analysis because maybe mom and dad have a very low basis in the property. And if we transfer the property prior to death, that tax basis transfers along with it, anytime that the kids receive property with the property tax basis, that transfer along with it, that built-in capital gain is still inside the property. So there's, there's this balancing act that needs to happen.
Ryan Lockhart (11:36):
When we look at the property tax savings for the parent to child transfer. Well, we're also going to look at what we're giving up and that is that step up in the tax basis on the income or capital gains tax side. And sometimes it makes sense to try to preserve, to step up in tax basis and give up the property tax reassessment, but not always, I mean, each case is different. And so that's why I would highly recommend a good analysis is done with an attorney to be able to, and a CPA probably to be able to determine really is where's the best tax savings is going to be for the family or really for the children, because all of these types of transfers, this type of estate planning is really about saving potential taxes for the children down the road when they do receive these properties.
Ryan Lockhart (12:22):
So how'd, you can see Prop 19 is a pretty, pretty big change when it comes to property taxes. When it specifically for parent to child transfers. So what are the solutions? I mean, this is the question I've been asked or receiving the most. The last couple of weeks is like, what options do we have? Well, because Prop 19 doesn't come in until February 16th. We do have the option of trying to make sure or complete these transfers prior to February 16th and under the Prop 58 rules. So that's one option, but some of the other options are a little bit different and it really applies more for if people have those other properties that we're talking about. You know, the vacation homes, that rental is the commercial properties, because there's a whole separate set of rules when it comes to entity level transfers. What are entities? Entities are corporations LLCs, limited liability companies.
Ryan Lockhart (13:12):
Partnerships. If you have a rental property commercial property in one of these types of entities, or maybe we can form the entity for this purpose, we can transfer up to 50% of the interest without triggering a reassessment. There's some qualifying factors in there, but let's just take a quick example. Mom and dad have a rental property. They form an LLC. They can share with the property to the LLC. Mom and dad are now a hundred percent owners of that LLC, which owns the property. Then mom and dad could transfer 50% of the LLC to the children. And because we haven't crossed this 50% threshold, then it doesn't trigger any sort of reassessment. So this is a way to push some of the property interests out to the children without triggering a reporting to the County or triggering a reassessment. That 50% number is not just 50%.
Ryan Lockhart (14:07):
It's a little bit more expansive than that. It's talks the way that these entity rules talk about this is they say, when they change a control or a change in ownership in the entity happens, that's when a reassessment happens. So they can, that's how they basically say, Oh, there's basically a new owner now this LLC, because they have a majority interest in the LLC, they can control the vote. So that's how it's at 50%. So if mom and dad had a hundred and they only gave 50, nobody has now gained a controlling interest. Nobody knew at least. And so we're still okay on the property tax reassessment side, the downside to this can be okay. So we transferred 50% of the LLC to the kids. Mom and dad still have 50%. Then when mom and dad die, the balance that LLC is going to go to the kids.
Ryan Lockhart (14:56):
Well, now the kids are going to go from 50% to a hundred. That would be when the change of control or change of ownership would happen and it would trigger reassessment then. So how do we avoid this? One way we do it is we'll roll the property into an LLC, do that 50% transfer and then dissolve the LLC. So now we have mom and dad as to a 50% interest in the property and the kids as to a 50% interest in the property directly, not through an LLC. Then when mom and dad die that 50%, that was in their personal names or their trust when that transfers to the kids, it's only that 50% that gets transferred. So it's a mitigation strategy. It's about trying to avoid a hundred percent reassessment and we'll kind of give up the 50% so we can preserve at least 50% without having to deal with Prop 19.
Ryan Lockhart (15:45):
Really. And we S you know, so that's, that's why I say it mostly applies to these other properties, usually income producing properties, but under Prop 19, when it comes to the primary residence, we are going to be stuck. It looks like with this requirement that the child has to live in the home and make it their own primary residence, and this million dollars above property tax basis, threshold, as far as the exemption is concerned. So, again, one of my recommendations, if you are looking at this type of a transfer and you want to, you think you want to try to transfer property before the February 16th date get moving as sooner than later, because the, these analysis that I mentioned earlier about step up in tax bases versus the property tax reassessment, that's a tax part of the analysis, but there's also a practical family look because it's a little unnerving for some people to say, okay, we'll transfer the prop, our home to our kids, but how can we preserve some of our rights?
Ryan Lockhart (16:48):
And, you know, that's, that's a lot to give up as far as control. You know, some families, you know, might be a little nervous about really granting those ownership rights to their children in a home that they fully intend to live in for the rest of their life. There's some other options that we can look at too including irrevocable trusts. But these are, they're a little tricky, so definitely need professional guidance. And I would highly recommend everybody reach out to them. Attorney, if you have any questions you want to give me a call, give me a call. I'm happy to work through this with you, because I've had those calls in the last couple of weeks, where as we start talking about the details of Prop 19, and we started looking at their own personal situations, it just, it just didn't make sense to make the transfer.
Ryan Lockhart (17:31):
Now, you know, they just said, you know what, it's just, it's too much risk to take on. And we're just not quite ready for that. So we'll just have to deal with Prop 19 and try to do some future planning to try to mitigate the effect of that reassessment under Prop 19 as much as possible. So again, I do expect, expect some guidance to come down, hopefully before Prop 19 comes into play in February, but I'm not holding my breath out for that too long, but we'll see. And I'll give everybody an update. So if you or anybody, you know, has any questions about Prop 19, you can reach out to me, give me a call. W you can reach me on the website, the link to our website, mckennabrink.com will be in the show notes. I'm also going to drop my direct line phone number in the show notes, because we, this is a short timeline that we have to look at this Prop 19.
Ryan Lockhart (18:22):
We only have two months, and as everybody knows in the holiday season, things can move fast or these was time. So the sooner we can start talking about this and analyzing it the better, but reach out to me and we'll, we'll work through this. And if at the end of the day, we, we just say, we're not going to do anything at the minimum. You got a little bit more understanding of how this property tax transfer is going to work under Prop 19. Thank you for listening to the episode today. I am Ryan Lockhart. This is, I Know a Lawyer and happy holidays. Everybody take care. Bye bye.