As I mentioned in my previous blog, Proposition 19 is a bit complex and therefore I decided to cover its different aspects over multiple blogs. Part-1 had focused on impact of Proposition 19 on primary homes. In this blog, I will cover impact of Proposition 19 on properties other than primary home (rental property, second home, vacation home).
Under current law, in addition to a primary home, each parent can transfer “other property”, such as a vacation home, rental or commercial property, and receive a lifetime exemption of up to $1 million in assessed value (not market value). In case of a married couple, each spouse may transfer $1 million for a total of $2 million in assessed value to their children without reassessment.
Proposition 19 changes these rules on parent transfers and abolishes the exemption on “other property.”
For example, under Proposition 19, if parents’ rental property has assessed value of $1.5 million and market value of $3 million, assessed value for child on transfer would be $3 million. Child’s property tax would be based on $3 million assessed value. It does not matter how the child uses this property.
Since property taxes are based on an assessed value of the property, which might not be the same as the market value, people are considering transferring the property to their children before February 16, 2021. If the property has assessed value that is less than the exemption amount and is owned by the children before this date, there will be no reassessment of the property. For transfers on or after February 16, 2021, Proposition 19 would apply, and the property would be reassessed.
Before such a decision is made, please note that this is not a one-dimensional issue. This decision has a multi-dimensional impact that includes property tax, income tax, gift tax, and estate tax.
If parents transfer the property to the children now, the transfer will eliminate step-up in basis. In addition, one also needs to consider gift tax. For 2021, basic exclusion amount (or lifetime exclusion) is $11.7 million per person. For a married couple, this is a combined exemption of $23.4 million. The deceased spouse’s unused exclusion amount can be ported to the surviving spouse.
If parents do not transfer the property now, and the children inherit the property at parents’ death, property gets a step-up in basis. However, one needs to consider the estate tax at the time of death. If the parents’ estate exceeds $23.4 million, estate tax rate is 40 percent.
Please note that under current law, the basic exclusion amount will be reduced by half starting January 1, 2026.
So, one tradeoff between transferring the property now versus inheriting is preserving property tax base versus step up in basis. Other tradeoffs are the gift tax and estate tax impacts. And equally important are the non‐tax consequences of transferring property or adding children to title of property. So, review your estate plan and consider the picture in its totality. This is a complex decision, consult a knowledgeable and experienced advisor to help you review all the variables.
One last note on non-primary home properties - properties owned in a corporation, limited liability company or other legal entity fall under different rules which have not been discussed here.