Special Alerts

After Proposition 19 Effective Date, Can You Still Plan To Reduce Taxes for Farms and Homes?

Prior to the passage of Proposition 19, parents or grandparents could transfer their primary residence and $1 million per parent of other real property to their children without triggering a reassessment of those properties. After Feb. 15, Proposition 19 significantly narrows that exclusion.

Beginning Feb. 16, a transfer of a personal residence or family farm to a child is only exempt if the residence becomes the primary home of the child, or the family farm continues to be used for agricultural purposes. In addition, transfers of family farms are limited in the same dollar amount manner as the transfer of personal residences.

In mid-December, the state’s Board of Equalization issued both a letter to assessors and a chart of issues raised and options regarding Proposition 19.

Read here who was behind this gutting of Proposition 13, and this massive tax increase: https://californiaglobe.com/section-2/california-split-roll-ballot-measure-destroys-prop-13-protections-for-california-farmers-threatens-rural-communities/

This YAHNIAN LAW CORPORATION Special Report will discuss the change in the property tax reassessment exclusion that applies to transfers of property between parents and children, effective Feb. 16, 2021 and how to compute the property tax effect.

Lesson: If you are going to own real property, always acquire it from a third party, through an LLC owned by you and your family. That way, there will be no change in ownership, and therefore no reassessment unless one person (directly or indirectly) ever acquires a majority interest in the LLC. If that never happens, then there will not be a change in ownership under current law.

1. The Basics

Your property tax base year value is the assessed value — the value listed on your property tax bill on which the property tax is calculated. It is typically the fair market value of your home at the time you bought it, adjusted annually by up to the 2% allowed under Proposition 13 (as adjusted, this is known as “factored base year value”). The property tax rate is 1% plus other voter-approved fees and assessments, which vary by county.

Under the law prior to Prop. 19, a parent could transfer their principal residence of any value and $1 million of base year value (per parent) in any other property(ies) to children without causing any property tax reassessments. Thus, a single parent could transfer their $1.2 million residence and a $3 million vacation home (as long as it had a base year value of $1 million or less; if two parents are making the transfer, the base year value can be $2 million) to their children, and the property taxes would not change. After Feb. 15, 2021, that will no longer be the case. (And note: the recorder’s offices are closed on Feb. 12-15, so the real cut-off date is Feb. 11, 2021.)

2. Limits of Parent-Child Transfer Exclusions

Prop. 19 eliminated any exclusion from reassessment for transfers between parents and children of any property other than

a family farm or
a residence that is used by the parent as their principal residence before the transfer and is used by the child as their principal residence within one year of the transfer. No other transfers will qualify for the exclusion from reassessment.

3. How Much Can Be Transferred?

Even if a child inherits a parent’s principal residence and moves into the home as their own principal residence, there may only be partial relief from reassessment, depending on the value of the home.

After Feb. 15, 2021, when a child inherits a principal residence from a parent, there are three options for how the “new” base year value will be determined.

If a child does not move into the transferred home as the principal residence within one year from the date of transfer, the property will be reassessed at its full fair market value as of the date of transfer (date of death, if that is how the transfer occurs). There is no ability to transfer the base year value.
If the child does use the transferred home: If the value of the transferred home is less than the factored base year value plus $1 million (indexed annually for inflation), the factored base year value will remain the same.

For example, assume John and Jane Jones have lived in their quaint Morro Bay home since they bought it in the early 1970s. Their tax base value is a mere $80,000, but the home is valued at $900,000. The tax base value $80,000 plus $1 million dollars is $1,080,000. Since the home is valued at less than that ($900,000), the property tax base value (the $80,000) can be transferred to their son Carl and no further adjustment is needed. Carl will pay the same as his parents did in property taxes.

If the child does use the home as their principal residence and the value exceeds specified value test: Here the math gets complicated. The language of Prop. 19 reads like an algebraic formula. To use an example with the use of algebra

Assume John and Janes’ Morro Bay home still has a tax base of $80,000, but the home is valued at $2 million.

If Carl moves into the home and files the homeowner’s property tax exemption within one year, his new property tax bill will be calculated as follows:

— Calculate the sum of the property tax base value plus $1,000,000

— $80,000 + $1,000,000 = $1,080,000

— Determine whether the fair market value exceeds the sum of the property tax base value plus $1,000,000

— $2,000,000 is greater than $1,080,000

— Calculate the difference

— $2,000,000 – $1,080,000 = $920,000

— Add difference to property tax base value

— $80,000 + $920,000 = $1million

— New combined base year value = $1,000,000

While Carl is certainly getting some advantage, his tax bill would be twice as much without the exemption. He will be paying substantially more in property taxes under Prop. 19 than his parents did or than he would have under prior law.

4. Questions and Issues Raised

a. Multiple children

The BOE points out in its Dec. 17, 2020 chart that it is unclear whether a transfer of a parent’s principal residence to multiple children could qualify for the base year value transfer. Must all of the children reside in the home as their principal residence to qualify, or is one child living there sufficient? At this point, further guidance or legislation is needed.

How long does the child have to live in the home? Also unknown is how long the child would need to reside in the home as their principal residence. If the child moves out, what, if anything, happens to the base year value?

b. Timing

Surprisingly, the BOE raises this question: For a transfer made prior to Feb. 16, 2021, but the application for the parent/child exclusion is filed after, which statute applies? In most circumstances, the date of transfer would be the relevant date. The fact that the BOE even raises this issue means that the cautionary approach would be to make a transfer and file for the parent-child exclusion before Feb. 16, 2021, if you desire to take advantage of the more favorable laws that apply currently.

c. Appraisals

Prop. 19 appears to require that all principal residences that transfer between parents and children be reappraised to verify qualification for the base year value transfer, if claimed. This is certainly going to increase an assessor’s workload, possibly delay approval of claims, and result in additional appeals.

d. Family farm

The ability to transfer the base year value between parent and child also applies to a transfer of a “family farm.”

While “family farm” is defined as “…any real property that is under cultivation or being used for pasture or grazing or to produce any agricultural commodity,” there is much that is unclear about a “family farm” transfer. Must it include a residence? Can a residence and a family farm be transferred? In the words of the BOE, “There will [sic] many questions as to what will qualify as a family farm.”

5. Proposition 19 Complicates Farm Property Transfers

Known as The Home Protection for Seniors, Severely Disabled, Families, and Victims of Wildfire or Natural Disasters Act of 2020, and passed by California voters last November, Proposition 19 affects taxes on homes and inherited property—and poses significant challenges for family farmers and ranchers.

As state agencies implement the new measure, the California Farm Bureau has been the only agricultural organization challenging interpretations and guidance the agencies have been using.

So far, Proposition 19 implementation is unclear, and property owners urgently need clarification from the state Board of Equalization. New guidance will be provided to county assessors. Expect legislative efforts will occur in 2021. In addition, Proposition 19 will likely face multiple legal challenges from California property owners.

a. The most pressing components of the measure that family farmers and ranchers face

Under the new law, even the transfer of a family farm or personal residence is limited, and may still face a partial property tax reassessment. The exclusion only applies as far as a certain, specified value—a new formula included within Proposition 19. Should a property exceed that specified value, anything above that would be assessed at fair market value—leading to a higher property tax bill.

Proposition 19 provides that if the fair market value of a family home or family farm is less than the sum of the factored base year value plus $1 million, the new factored base year value would not be adjusted. In that case, a child could assume the family home or family farm with the property taxes paid by their parents.

However, if the fair market value is equal to or more than the sum of the factored base year value plus $1 million, an amount equal to the fair market value of the family home or family farm—minus the sum of the factored base year value plus $1 million—is added to the original base year value of the transferred property.

It appears that a farmer would use the above computations in the residence example, to determine how much of a change of property tax, if any would result from a transfer of farm property. These new rules severely limit and impact transfers of farm property.

Assume John’s and Jane’s Kings County ranch still has a tax base of $80,000, but the ranch is valued at $2 million.

If they transfer the ranch to their son, Carl, his new property tax bill will be calculated as follows:

— Calculate the sum of the property tax base value plus $1,000,000

— $80,000 + $1,000,000 = $1,080,000

— Determine whether the fair market value exceeds the sum of the property tax base value plus $1,000,000

— $2,000,000 is greater than $1,080,000

— Calculate the difference

— $2,000,000 – $1,080,000 = $920,000

— Add difference to property tax base value

— $80,000 + $920,000 = $1million

— New combined base year value = $1,000,000

6. So, What Does Proposition 19 Mean For Our Clients?

With the passage of Proposition 19, we will see an increase in property taxes for transfers of California real property between parents and children or vice versa. This means that transfers using Trusts, LLCs and partnerships are more important than ever.

a. Parent–child transfers

Under current law, a transfer of ownership in California real property generally results in a reassessment for property tax purposes with certain exceptions, including two exclusions from reassessment that can apply for transfers between parents and children:

The principal residence exclusion allows the transfer of a principal residence of unlimited value between parents and children; and
The $1 million lifetime non-principal residence exclusion allows the transfer between parents and children of up to $1 million of assessed value of all other types of property (for example, second homes or rental properties). For a married couple, this would be a combined $2 million lifetime exclusion. Note: Starting in 2023, this amount will be indexed for inflation.

Under Proposition 19, for transfers on or after February 16, 2021:

In order to qualify for the principal residence exclusion, the receiving child must use the residence as their own principal residence, and only the first $1 million of additional assessed value is excluded;1 and
The non-principal residence exclusion has been completely eliminated. However, the principal residence exclusion will apply to transfers of family farms.

b. Old transfers won’t be reassessed

The change only applies to transfers on or after February 16, 2021. Transfers that occur prior to that date will continue to follow the pre-Proposition 19 rules and will not be reassessed after the new law is enacted.

c. Complicated reassessment formula

Proposition 19 requires assessors to calculate the new taxable value, or new assessed value, of the property using the following formula:

If the FMV immediately before the transfer is less than the assessed value plus $1 million, then the property will not be reassessed; and
If the FMV immediately before the transfer is equal to or more than the assessed value plus $1 million, then the new assessed value = assessed value + FMV immediately before the transfer – (assessed value + $1 million).2

Example of no reassessment: Judy dies, and her daughter Jessica inherits her home. At Judy’s death the home has a FMV of $1.25 million and an assessed value of $500,000.

The $1.25 million FMV is less than $1.5 million (the $500,000 assessed value + $1 million).

As a result, the assessed value remains at $500,000 when Jessica inherits the property.

Example of reassessment: Lucy dies, and her son Leon inherits her home. At Lucy’s death, the home has a FMV of $2 million and an assessed value of $500,000.

The $2 million FMV is more than $1.5 million (the $500,000 assessed value + $1 million).

As a result, the new assessed value is $1 million (($500,000 + $2 million) – ($500,000 + $1 million)).

d. Unless you get planning advice and documentation from us, think twice before you gift property now or in the future.

Families with real estate that they are planning to pass from parent to child may want to make transfers before February 16, 2021, to preserve low property tax bases. If the children plan to keep the property to rent or use as a second home, this could save a tremendous amount of property tax in the future. However, if the children will likely sell the property, consider that making a lifetime gift will preserve the property tax base, but it will eliminate the income tax step-up in basis that the children would get if they inherited the property at their parent’s death. However, we have ways to both minimize property taxes and get step up in income tax basis at death. This strategy is still available even after February 15, 2021. There are legal strategies that will still allow the basis step up, even after a gift to the children.

e. Remember, use an existing LLC or a partnership (limited partnership is best) or set up a new LLC or limited partnership to make future acquisitions of real property from third parties.

This includes the use of trusts, partnerships and LLCs. Never use a corporation as trapping appreciated real property inside of a corporation can have severe income tax consequences.

e. Base-year transfers

For transfers on or after April 1, 2021, Proposition 19 also allows taxpayers who are over age 55, severely disabled, or a victim of a wildfire or other natural disaster to transfer their property tax adjusted base-year value to a replacement property anywhere in the state (currently this benefit is limited to counties that have authorized the base-year property transfer).3

Taxpayers who are over age 55 or disabled will be able to transfer the base-year value of the relinquished property up to three times. Disaster victims can make these transfers for an unlimited number of disaster-related transfers.

In addition, these taxpayers are no longer limited to replacement properties of equal or lesser value. If they purchase a replacement property with a higher FMV than their original property, the assessed value of the replacement property would be equal to the assessed value of the original property, plus the difference in FMV between the original property and the FMV of the replacement property.

Example of higher FMV: Jane is age 65 and has decided she wants to move closer to her grandchildren. She sells her home in Orange County, with an assessed value of $400,000, for $650,000. Jane purchases a new home in San Diego for $750,000.

The assessed value of Jane’s new home is $500,000 ($400,000 + ($750,000 – $650,000)).

Unfortunately, the BOE has noted that Proposition 19 is unclear as to whether one event (either the sale of the original residence or the purchase or construction of the replacement residence) or both events must occur on or after April 1, 2021, in order to qualify for this base-year value transfer. They have stated they are awaiting legislation to clarify this issue and other items that were not addressed in the proposition language.4
Client letter

Proposition 19 §2.1(c)(1)
Proposition 19 §2.1(c)(1)(B)
Proposition 19 §2.1(b)
Letter to County Assessors No. 2020/61

f. Another Family Farm Example

A farm has been held by a family for several years and has a factored base-year value of $425,738. The last surviving parent passes away, and the property is inherited by the only child. The child intends to continue the operation of the family farm and, at the time of the parent’s death, it has a fair market value of $1,750,000. To determine the value under Proposition 19:

Calculate the sum of the factored base-year value plus $1 million: $425,738 + $1,000,000 = $1,425,738.
Determine whether the fair market value exceeds the sum of the factored base-year value plus $1 million: $1,750,000 is greater than $1,425,738.
Calculate the difference: $1,750,000 – $1,425,738 = $324,262.
Add the difference to the factored base-year value: $425,738 + $324,262 = $750,000.

That leaves a new combined base-year value of $750,000.

You should be aware that if the family farm were treated as all other real property under Proposition 19, the taxes paid would be based on the actual fair market value of the farm, or $1,750,000, as compared to the new combined base-year value of $750,000 based on the example provided. That would equate to $17,500 in new property taxes paid by the child upon transfer, instead of $7,500.

Many questions remain related to Proposition 19. Farmers looking to pass their farm or personal residence should seek advice immediately from YAHNIAN LAW CORPORATION.

The Board of Equalization has said the filing of a notice of transfer is not acceptable for utilizing the earlier transfer benefits, and that the transfer itself must take place before Feb. 15—or anything after will be calculated based on Proposition 19.

There are many nuances that make this challenging. Contact us to discover the impacts this may have on family farmers and ranchers.

7. Williamson Act Impact

Farms for which the Williamson Act has been elected, will still be taxed under the Williamson Act, even after a transfer to a child or entity, so long as the transferee continues to farm the property. However, if the then owner elects to terminate Williamson Act status for the property, the property will revert to assessment under the then assessment rules.

About the Author
D. Steven Yahnian has been a member of the California Bar and a practicing Attorney since 1980. He has also been a California CPA since 1984. Mr. Yahnian also holds the CFP® designation.

Mr. Yahnian practices in the following areas of law through YAHNIAN LAW CORPORATION:

Estate Planning & Administration
Asset Protection Planning
Tax Planning, Tax Debt Resolution and Tax Litigation
Business & Corporate Law and Planning
Real Property Law & Planning

As a CPA/CFP, Mr. Yahnian also has a separate accounting and tax return preparation practice called DSA ACCOUNTING.

Mr. Yahnian is a California State Bar Certified Specialist in the following
• Taxation Law and
• Estate Planning, Trust & Probate Law.

Mr. Yahnian received a B.S. degree in Accounting from USC, a J.D. from Loyola University of Los Angeles School of Law and an LL.M. in Taxation from New York University Law School. He also has a Certificate in Taxation from UCLA (with distinction).