“Understanding Prop 19: Guide for Heirs Inheriting Property in California”

Introduction

Congratulations on inheriting a house! While this can be an exciting time, it is crucial to understand the legal and financial implications of your new property. One important piece of legislation to consider is Proposition 19, a California law passed in November 2020. This blog post will outline how Prop 19 changed tax shelters for inherited properties, provide resources to help you better understand the legislation, and discuss the different populations affected by Prop 19.

The Changes Brought About by Prop 19

Before Prop 19, California’s Proposition 13 (passed in 1978) allowed for a generous property tax shelter from generation to generation. When inheriting a property, children and grandchildren could maintain the low property tax base of their parents and grandparents. This tax break could apply to any property, regardless of value or the heir’s use of it.

Prop 19 significantly altered the tax implications for inherited properties. Now, the property tax break is limited to a primary residence inherited by a child or grandchild, and the property must be occupied as the heir’s primary residence within one year of the parent’s passing (1). Additionally, if the property’s market value exceeds the taxable value by more than $1 million, the heir’s tax base will increase (2).

Let’s Dive In A Little Further: 

Under Proposition 19, if an heir inherits a house in California and does not plan to make it their primary residence, they will not benefit from the parent-child or grandparent-grandchild tax exclusion that would have otherwise allowed them to maintain the property’s low tax base. As a result, the property tax will be reassessed at its current market value when it is transferred to the heir (1).

This can lead to significantly higher property taxes for the heir compared to what the previous owner paid, especially if the property has appreciated considerably over time. The reassessment to the current market value could cause a substantial financial burden for the heir, depending on the difference between the previous tax base and the current market value of the property.

It is essential for heirs to consider the financial implications of Prop 19 when inheriting a property in California and to consult with a tax professional or real estate expert to understand the potential impact on their specific situation.

Now, let’s say that the property ends up being valued above 1M? What happens then? 

Under Proposition 19, if an heir inherits a property with a market value gain of more than $1 million, their new tax base is calculated by adding the amount exceeding $1 million to the property’s original taxable (assessed) value. This only applies if the heir plans to use the inherited property as their primary residence.

To clarify, let’s consider an example:

1. The original assessed value of the property (parent’s tax base) is $500,000.
2. The current market value of the property is $1,600,000.
3. The market value has increased by $1,100,000 ($1,600,000 – $500,000), which exceeds the $1 million threshold.
4. The amount exceeding the $1 million threshold is $100,000 ($1,100,000 – $1,000,000).

The new tax base for the heir would be the original assessed value plus the amount exceeding the $1 million threshold: $500,000 (original assessed value) + $100,000 (excess) = $600,000 (new tax base).

Prop 19 considers the market value of the property when determining if the $1 million threshold has been exceeded. However, it is essential to note that this provision is only applicable if the heir plans to use the inherited property as their primary residence.

If the heir does not plan to make the inherited property their primary residence, the property will be reassessed at its current market value, and the tax will be calculated based on that new assessed value, without any exclusion.

So What would that look like? 

Under Proposition 19, if an heir does not plan to make the inherited property their primary residence and instead intends to sell, the property will be reassessed at its current market value for property tax purposes. In the given scenario, the current market value of the property is $1,600,000.

Upon inheriting the property, the heir would be responsible for the property taxes based on the reassessed value of $1,600,000. However, it’s important to note that the increase in property tax will be prorated based on the date the property was transferred to the heir. If the heir sells the property soon after inheriting it, their property tax liability will be relatively short-lived.

As for capital gains taxes, the heir would receive a step-up in basis for the property upon the decedent’s death. This means the heir’s basis in the property would be the fair market value at the time of the decedent’s death, which in this case is $1,600,000. If the heir sells the property at the same market value, they would not owe any federal capital gains taxes, as there would be no gain realized.

It is advisable to consult with a tax professional or real estate expert to fully understand the tax implications specific to the heir’s situation.

What Other Populations Are Affected by Prop 19

While Prop 19 primarily affects heirs who inherit property in California, it also has implications for other populations. These include:

1. Homeowners over 55 years old, people with severe disabilities, and victims of natural disasters: Prop 19 allows them to transfer their current property tax base to a new primary residence up to three times, within certain limits
   

Here’s an example to illustrate how this tax base transfer would work:

1. Homeowner A, who is over 55 years old, has a primary residence with an original assessed value (tax base) of $300,000. The current market value of their home is $800,000.
   
2. Homeowner A decides to sell their home and buy a new primary residence for $900,000. Since the new home’s market value is within the limit (equal to or less than the market value of the original home plus $1 million under Prop 19), they can transfer their current tax base.
   
3. Homeowner A’s new property tax base will be calculated by taking the original tax base of $300,000 and adding the difference between the new home’s purchase price and the old home’s market value: $300,000 (original tax base) + ($900,000 – $800,000) = $400,000 (new tax base).
   
4. Homeowner A pays property taxes on the new home based on the new tax base of $400,000.
   
5. If Homeowner A decides to move again, they can transfer their tax base up to two more times, as long as they meet the eligibility requirements and the new home’s market value falls within the specified limits.
   

Please note that these tax base transfers are only allowed within California and might be subject to additional county-specific rules.

Why the change and where are these increased taxes going? 

Proposition 19 generates revenue for fire protection, emergency response services, and schools by reassessing inherited properties at their current market value if they do not qualify for the parent-child or grandparent-grandchild exclusion. This leads to higher property taxes for some inherited properties, particularly those that were previously subject to a lower tax base under the previous legislation (Proposition 13). The increased property tax revenue can then be allocated to support various public services, including fire protection, emergency response, and schools.

The revenue generated from these higher taxes is distributed through the creation of the California Fire Response Fund (CFRF) and the County Revenue Protection Fund (CRPF). Proposition 19 mandates that 75% of the revenue be allocated to the CFRF, which supports fire protection and emergency response services. The remaining 25% of the revenue is allocated to the CRPF, which reimburses counties for revenue losses due to the new property tax transfers allowed by Prop 19. Any excess funds in the CRPF will be distributed to school districts and community colleges (1).

Proposition 19 was voted on during the November 3, 2020, general election in California and passed with a 51.1% majority. The provisions related to the parent-child and grandparent-grandchild exclusions became effective on February 16, 2021, while the provisions related to the tax base transfer for seniors, persons with disabilities, and disaster victims became effective on April 1, 2021 (2).

References:

Where Else Can I Gather Info About Prop 19?

Four Helpful Resources 

1. California Legislative Analyst’s Office (LAO): A nonpartisan fiscal and policy advisor, LAO offers an overview of Prop 19, discussing its impact on inherited properties and the overall fiscal effect on the state. Their website provides a detailed analysis of the legislation (3).
   
2. California State Board of Equalization (BOE): As the agency responsible for property tax administration, the BOE offers a comprehensive guide to understanding Prop 19. Their website includes frequently asked questions, answers, and examples to help heirs navigate the law (4).
   
3. California Association of Realtors (CAR): CAR is a professional organization for real estate agents and offers resources for both realtors and the general public. Their website has a page dedicated to Prop 19, explaining its implications and providing links to other helpful resources (5).
   
4. California State Assembly: The official website for California’s legislature provides the full text of Prop 19, allowing you to read the law in its entirety (6).

Conclusion

This information is being provided in not tax advice and should not be construed as such. You should consult professional resources such as a CPA, estate lawyer, or tax attorney before making any decisions

Inheriting a house comes with several responsibilities and complexities, especially with the recent changes brought about by Prop 19. As an heir, it’s crucial to familiarize yourself with the law and its implications for your inherited property. Be sure to consult the provided resources and consider seeking professional advice to navigate this complex issue.

References (for this article) :

1. Legislative Analyst’s Office. (2020). Proposition 19: Changes Certain Property Tax Rules. Retrieved from https://lao.ca.gov/ballot/2020/Prop19-110320.pdf
   
2. California Secretary of State. (2020). Statement of Vote – November 3, 2020, General Election. Retrieved from https://elections.cdn.sos.ca.gov/sov/2020-general/sov/complete-sov.pdf
   
   
3. State Board of Equalization. (2021). Proposition 19 – Parent-Child and Grandparent-Grandchild Exclusion. Retrieved from https://www.boe.ca.gov/prop19/