CA Prop 19 Passes and Opportunities Prior to Biden Tax Laws
FOR THOSE WITH CA REAL ESTATE: California Prop 19 – Children Inheriting Will Be Impacted
Though most of our clients are not residents of the State of California, many of our clients do own real estate in California. Moreover, and even though we are not licensed to practice law in the State of California, we desire to direct your attention to the recent passage of California’s Proposition 19, which was approved by California voters in the November election. Prop. 19 marks a landmark change to Prop. 13, the 1978 law that aimed to limit property taxes.
Among other changes to Prop. 13, many people will experience a negative impact from Prop. 19, since it considerably limits the availability of the parent-child exclusion for purposes of limiting reassessment of real estate property taxes upon the transfer of property from parents to children.
Prior to Prop. 19’s passage, parents could transfer a primary residence to children without any new fair-market reassessment, regardless of how the children chose to use the real property. Effectively, this allowed children to continue with the same (often much lower) property tax basis that their parents enjoyed.
Additionally, any secondary property, such as a vacation home, rental property or commercial property, could be transferred with up to $1 million of the assessed value being exempt from the increase in property taxes, again, regardless of its use by the children.
Beginning February 16, 2021, children who inherit real property from their parents will have to take into account increased property taxes in their decision to keep or sell California property, following a transfer of the property to them from their parents.
If a child chooses to keep the real estate and use it as the child’s primary residence, then up to $1 million of the reassessed value will be excluded from the new property-tax basis. (Before, primary residences could be transferred with no cap.) If the child chooses to keep the property as a second home, vacation home or rental property (anything other than as the child’s primary residence), there is no exclusion and the child will possibly face a significant increase in property taxes.
For example, if Mom and Dad purchased a rental property in 1950 for $60,000, and the value of the rental property is now more than $1 million when it is transferred to a child, after February 16th, Mom and Dad’s tax basis will no longer pass to child, and child will pay property taxes based upon the now much higher property tax basis.
This may significantly affect a child’s decision (and even ability) to keep or sell a California residence.
Summary: If you own California real estate, you only have until February 16th to transfer such property to your children without a possible increase in property tax basis. If you have questions, you should consult with a California attorney.
FOR THOSE WITH ESTATES OVER $5 MILLION: Opportunities Prior to Enactment of New Tax Laws
With the New Year here and a Democratic-controlled Senate looking certain after the runoff Senate elections in Georgia, President-elect Joe Biden’s tax plans are unlikely to suffer from any lack of bipartisan support.
From what we can tell, those plans include many increases to personal and corporate tax rates (related to ordinary income and capital gain income), as well as changes that would limit various deductions which currently reduce taxable income.
As related to estate planning, our firm’s area of expertise, the President-elect’s proposals have also included the elimination of the basis step-up for inherited assets. Under current law, the federal income tax basis of an inherited capital-gain asset is stepped up fair market value as of a decedent’s date of death. So, if heirs later sell those inherited capital-gain assets, they only owe federal capital gains tax on the post-death appreciation, if any.
This provision can be a huge tax-saver for appreciated inherited assets, such as personal residences, that were acquired many years ago for next to nothing and are now worth a great deal. The Biden plan would eliminate this tax-saving provision.
Moreover, on the campaign trail Mr. Biden talked about reducing the Estate/Gift/GST (transfer tax) exemptions from $11.7 Million per person (in 2021) to $5 Million or less. This would be a reduction of nearly $7 Million (or more) of exemption, equating to nearly $2.8 Million (or more) in increased taxes for large estates, with such calculation based upon our current 40% transfer tax rate. The new administration might also consider an increase in the transfer tax rate to 45% or higher.
Because of the possibility of increased transfer taxes and the probability that basis step-up for inherited assets will be eliminated, it makes sense to consider a gifting strategy in 2021, prior to the enactment of a new tax law.
If such tax laws are passed, it is unclear whether they would become effective (1) retroactive to January 1, (2) upon enactment, or (3) prospectively to the beginning of 2022. What seems sure, is that you should consider your options now.
If you have an estate valued at more than $5 Million, please call Mark Dodds or David Grant to discuss your particular situation.