Death, Taxes and Proposition 19

In one of his letters back in 1789 Benjamin Franklin said that “in this world nothing can be said to be certain, except death and taxes”.  Unfortunately, the latter seems to be getting more and more complicated each year.  Something new that homeowners will have to consider is Proposition 19, which will alter the way property taxes are being assessed and collected both for us and for our heirs.

The first phase of Proposition 19 just came into effect on February 16th of 2021.  The rest will kick in on April 1st.  It may not affect your immediate plans to buy or sell your home, but it will definitely influence the way the real estate market works and how homeowners manage their holdings.

As we all know, for the longest time California has been facing a severe shortage of housing, especially in urban centers like here in the Bay Area.  This housing deficit is driving home prices up making Silicon Valley living prohibitively expensive for many people.  The intention of Prop 19 is to make it easier and more affordable for homeowners who are 55 or older to move to homes that better fit their needs or downsize.  This will hopefully make more homes available for new families and first-time home buyers.

So, what is Prop 19?  Prop 19 is an amendment to the California Constitution that was voted in during the fall elections in 2020.  It alters the existing rules related to the transfer of the tax basis when people over 55, severely disabled homeowners or victims of wildfires or natural disasters move their primary residence as well as intergenerational transfers, from parents to children.

Proposition 19 supersedes Props 60 and 90 but there are 3 major differences between the old rules and the ones.

First, it allows homeowners to sell their primary residence and to transfer the tax basis of that home to the purchase of a replacement property anywhere in the State of California as long as it is their new primary residence.  Under prior law, the seller was limited to transfers either within the same county (Proposition 60) or between a limited number of counties that specifically permitted such taxable value transfers (Proposition 90).

Second, it allows the transfer of the tax basis of the sold primary residence to the replacement principal residence regardless of the difference in their values.  Certain adjustments to the tax basis will be required if the replacement home is of "greater value" than the original sold property.  Under prior law, only transfers of "equal or lesser value" were eligible for the exemption.

And third, Proposition 19 permits such transfers up to three times (or unlimited for those whose homes were destroyed or substantially damaged by wildfires). Prior law allowed such transfers only one time.

The replacement primary residence “equal or lesser value” rules are subject to an inflation index.  The replacement home value can be up to 105% of the old home’s value if it is purchased within one year of sale of the original property, and up to 110% if purchased within the second year of the original sale.

The replacement residence also can be of greater value than the original home.  The rules are easier to understand by looking at this example (I am using round number to make it easier to follow):

Original primary residence taxable value $400,000
Sale Price $1,000,000
Difference between the home values (1.2M – 1.0 M) $1,200,000
Taxable value of the replacement property $200,000
Taxable value of the replacement property $600,000

Proposition 19 also changes the rules of intergenerational transfer that used to be governed by Propositions 58 and 193.  The major changes are:

First, Proposition 19 limits the exemption from reassessment for intergenerational transfers to the transfer of a primary residence to a child or grandchild only when the property continues to be used as a family home by them. For example, if you inherit a home from your parents and plan to live in it full-time, then you will inherit the tax basis.

However, secondly, if the difference between the value of the home at the time of the transfer is higher than the original tax basis by more than $1M, the new tax basis will be the current value of the home minus $1M.  Let us look at this scenario:

Original tax basis $500,000
Value of the property at the time of transfer $2,100,000
New tax basis will be (value minus $1M) $1,100,000

The old rules simply transferred the original tax basis to the child without the primary residence test and without the $1M in taxable value exemption.  My understanding is that this tax exemption will be lost, and the home will be assessed to its full market value if the new owner moves out of the home.

In our experience here in the Bay Area, the decisive factor influencing the owner’s decision to sell their home is often capital gain taxes, not just property taxes.  Capital gain taxes can run in the hundreds of thousands between federal and state taxes.

Each homeowner’s situation is different, and we recommend you review your plans with a qualified California attorney.  Prop 19 rules are still subject to implementing legislation and its effects on the real estate market are hard to predict.

We work only with a small number of buyers and sellers at a time to be able to provide our 5-star service.  Call me or send me a text so we can start planning your next move together!

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