Protecting Your Estate from California’s Prop 19

In California, real estate can make up a significant portion of the wealth someone has to pass down to their heirs, particularly if they have owned a home for decades and its value has skyrocketed. Once, property owners could leave their principal residence and up to $1 million of income or other real estate to their family without having their property taxes reassessed, which preserved the value of the gift and the next generation’s freedom to use the property as they wished. Unfortunately, the passage of Proposition 19, The Home Protection for Seniors, Severely Disabled, Families, and Victims of Wildfire or Natural Disasters Act, which was passed by California voters in 2020, severely restricts the conditions under which a property’s tax basis can be passed down with the property. Without careful, proactive estate planning, this can leave heirs with a new property tax bill that makes it prohibitively expensive to keep the real estate they inherited.

Understanding California’s Property Tax Laws

In 1978, Proposition 13 was passed, amending the state constitution to provide property owners with relief from soaring property tax bills. It limits the property tax rate to 1% of a property’s assessed value at the time of purchase, in addition to local and county taxes. Annual tax increases are limited to a maximum of 2%. Property is not fully reassessed until it is sold.

Proposition 58, which went into effect in 1986, created a parent-child exclusion that exempted the parent’s principal residence from reassessment when it was transferred to the child—the beneficiary inherited the parent’s assessed value as well, regardless of the current value of the property when it was transferred. Prop 58 allowed the new owner to use the property as a rental, vacation property, or as their principal residence, imposing no requirements in order to keep the benefit of the lower inherited property tax bill. Further, parents were able to transfer up to $1 million of other real property (residential or commercial) to their heirs without triggering reassessment.

Prop 19 eliminates the parent-child exemption for any real estate beyond the principal residence and imposes strict conditions under which the family home would qualify for an exemption. To avoid reassessment, the child or grandchild inheriting the property must use the property as their primary residence and move into it within one year of the transfer. In addition, they do not automatically assume the parent’s taxable value for the property. Their taxable value is determined by whether the property’s assessed value (current market value) exceeds the previous taxable value by over $1 million. If the value does not exceed that figure, the property tax does not change. If it does, the balance is taxed at fair market value and that amount is added to the inherited tax bill.

Should the beneficiary wish to keep the property but not make it their primary residence, its property tax would be reassessed to the current fair market value of the property, as would the property tax bills of any other real estate included in their inheritance. This significantly changes the math on the cost of inheriting investment properties, but this effect can be mitigated with preemptive estate planning.

Using LLCs to Avert Property Tax Reassessment

Real estate that is owned by a limited liability company (LLC) is not subject to the same rules for property transfers and taxable value as properties that are owned by individuals. When the LLC is the property’s original owner, as long as no new person gains more than 50% ownership or control of the LLC, then the underlying property will not be reassessed. Property transfers for inheritance purposes need to be carefully planned so that no one beneficiary gains more than 50% interest or control in the LLC. If the property is transferred into or purchased by the LLC and then more than 50% of the ownershipis transferred to anyone other than the original co-owners, the entire property will be reassessed. This means a more sophisticated approach is needed to effectively transfer ownership of the property to a business entity without triggering reassessment.

The key to using LLCs to delay property tax reassessment under Prop 19 is working in advance with the assistance of an experienced estate and business planning attorney. Creating a successful tax minimization strategy takes both time and expert advice tailored to your individual circumstances.

Solving Complex Estate Planning Challenges

A comprehensive estate plan is about much more than simply deciding who gets what when you’re gone. The business and trust transactional attorneys at NM Law use our knowledge of the law and our experience in crafting complex estate plans to minimize your tax liability and preserve the value of what you have worked hard to pass on to your heirs. If you’re concerned that your real estate holdings are vulnerable to property tax reassessment upon transfer, we can help you find solutions. Contact us here to schedule your consultation today.