Of Counsel
California’s Proposition 19, which took effect on February 16, 2021, has drastically altered the landscape of real estate inheritance and property transfers within families. For years, California families could pass down homes from parents to children while retaining the same low property tax assessments, allowing heirs to enjoy the benefits of relatively low taxes on valuable real estate. However, Proposition 19 has fundamentally changed this dynamic, introducing new rules that complicate the gifting of real estate from parents to children, particularly in cases where the property is not the recipient’s primary residence.
Understanding how Proposition 19 interferes with the gift-giving of real estate involves a closer look at the key provisions of the law, its intended goals, and its unintended consequences for families. While the proposition offers benefits to some homeowners, particularly seniors and disaster victims, it poses significant challenges for families seeking to transfer real estate as a gift.
The Pre-Prop 19 Landscape: Proposition 58 and Property Tax Protection
Prior to the passage of Proposition 19, California law allowed parents to transfer property to their children without the property being reassessed for tax purposes. This provision, under Proposition 58 (passed in 1986), ensured that the child could inherit the home or other real estate with the same low property tax base that the parents had, even if the property had significantly appreciated in value over time.
For example, if parents purchased a home in the 1970s for $100,000, their property taxes would be based on that original purchase price, adjusted for inflation under Proposition 13, another landmark law passed in 1978 that capped annual property tax increases at 2%. When they transferred the property to their children, the children could continue to pay taxes based on the original assessment, regardless of the property’s market value at the time of transfer.
This system allowed families to pass down wealth in the form of real estate without burdening heirs with drastically increased property tax bills. For children who inherited family homes or rental properties, the ability to maintain the same property tax base was often a key factor in their decision to keep or live in the inherited property.
Proposition 19: What Changed?
Proposition 19 was billed as a solution to various problems within the state’s property tax system. Its primary selling points were expanded property tax breaks for homeowners over 55, disabled homeowners, and victims of wildfires and natural disasters. The proposition allows these groups to transfer their existing property tax base to a new home anywhere in the state up to three times, making it easier for seniors to downsize or relocate without facing substantial tax increases.
However, buried within the proposition was a major change to the rules governing intergenerational property transfers. Proposition 19 repealed most of the benefits of Proposition 58, particularly for properties that are not the primary residence of the child receiving the gift.
Under Proposition 19, when a parent transfers a property to a child, the property will be reassessed at its current market value unless the child moves into the home and makes it their primary residence. Even in cases where the child moves into the home, the tax benefit is capped: the child can only retain the parent’s tax base if the home’s assessed value is within $1 million of its market value. If the home has appreciated beyond that threshold, the property will be reassessed, and the child will face a significant tax increase.
For example, let’s say a parent transfers a family home in Los Angeles, which was purchased decades ago for $150,000 and is now worth $2.5 million. If the child decides to live in the home as their primary residence, they can retain the original tax base, but only on the first $1 million above the assessed value. In this case, the child will be taxed based on an assessment of $1.15 million ($150,000 + $1 million), which could result in a significantly higher tax bill than the parents were paying. If the child does not move into the home, the entire property will be reassessed at its full market value of $2.5 million, potentially creating an unaffordable tax burden.
The Impact on Gift-Giving of Real Estate
One of the biggest consequences of Proposition 19 is that it severely limits the ability of parents to gift real estate to their children without triggering a substantial increase in property taxes. For families who own multiple properties—such as a family home and one or more rental properties—the new rules can make it financially untenable for children to hold onto inherited properties.
Rental properties and vacation homes are particularly affected. If a child inherits a rental property that the parents purchased decades ago, Proposition 19 requires the property to be reassessed at its current market value upon transfer. The reassessment can lead to a dramatic increase in property taxes (in some cases a 10 fold increase), potentially forcing the child to sell the property if they are unable to cover the higher tax costs.
This presents a major obstacle for parents who wish to gift rental properties to their children as a form of generational wealth before the expiration of the $14 million lifetime gift exclusion on December 31, 2025. Prior to Proposition 19, parents could transfer rental properties without triggering reassessment, allowing children to retain the same low property tax base and continue generating income from the property. Now, the sharp increase in taxes could wipe out much of the financial benefit of inheriting such properties.
Unintended Consequences and Challenges for Families
While Proposition 19 was designed to help certain homeowners and generate additional tax revenue for the state, its provisions on property transfers have created significant difficulties for families hoping to pass down real estate. The measure has made the gift-giving of real estate a more complex and costly process, particularly for children who inherit properties that are not their primary residence.
In some cases, families may need to explore alternative strategies for transferring property, such as establishing trusts or other estate planning vehicles. However, these strategies can be costly to set up and maintain, and they may not fully mitigate the impact of Proposition 19’s reassessment rules.
Ultimately, the changes introduced by Proposition 19 represent a shift in California’s approach to property tax benefits and inheritance, with potentially far-reaching consequences for families. While the measure provides benefits for certain groups of homeowners, it complicates the traditional practice of passing down real estate within families, raising new challenges for those seeking to preserve generational wealth in the form of property.
Conclusion
Proposition 19 has altered the framework of intergenerational property transfers in California, making it more difficult for parents to gift real estate to their children without triggering significant tax increases. Families must now navigate these new rules carefully, balancing their desire to pass down property with the financial realities created by Proposition 19’s reassessment provisions. As a result, tailored estate planning has become more crucial than ever for those looking to protect their real estate legacies.