On November 3, 2020, Californians voted to pass Proposition 19. This amendment to the California constitution will have a huge, negative impact on preserving low property tax rates in property transfers between parents and children by substantially narrowing which transfers will qualify for the exclusion once Prop 19 takes effect on February 16, 2021.

Previously, California real property owners could transfer their primary residence of any value to their children with their children retaining the parents’ property tax basis. In addition, California real property owners could transfer up to $1 million of assessed value of their other California real property to their children with the children receiving the parents’ property tax rate.  This is referred to as the “parent-child” exclusion. Similar rules applied to certain transfers between grandparents and grandchildren (e.g., when the grandchildren were orphaned) and for transfers from children to parents.

Unfortunately, the newly passed Proposition 19 guts most of these property tax protections for transfers between parents and children.

Prop 19 narrows the rules transfers from parents to children as follows:

1. Limits Parent-Child Exclusion to the Family Home and Farms. Starting February 16, 2021, Prop 19 will limit the parent-child exclusion to only two kinds of property transfers: (a) the family home (i.e., the parents’ residence that becomes the child’s residence within a year after the transfer) and (b) certain farms. Properties used for any other purpose – such as a vacation home or rental home or commercial property – will no longer qualify for the parent-child exclusion and the property tax rate will be reassessed for fair market value on the date of the transfer (i.e., date of gift or date of death).
2. Requires Tax Bill to Go Up for High Value Inherited Homes and Farms. In addition, starting February 16, 2021, there will no longer be an unlimited transfer of the family home to a child. Instead, the property tax bill for an inherited home or farm will increase if the price the property could be sold for exceeds the property’s assessed value by more than $1 million (adjusted for inflation every two years).

Before rushing to transfer a property to your child, however, you must compare the advantage of preserving your property tax basis with the potential disadvantages of such a gift. For example, by gifting real property during your lifetime, your child would have the same income tax cost basis that you have (i.e., “carry over” income tax cost basis). If your child then sold the property during his or her lifetime, your child could be liable for huge capital gains tax. In contrast, if your child inherited the property on your death, then your child’s income tax cost basis becomes the fair market value on your death, which often can be an enormous income tax benefit if your child then sells the property during his or her lifetime. Also, for rental property, this so-called “stepped up cost basis” oftentimes affords beneficial income tax deductions.

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