CALIFORNIA PROP 19: What you need to know
So the voting is over and California Proposition 19 won by the narrowest of margins. But what does it actually mean to you? How is it going to affect your real estate transactions? I think in 2021, when Prop 19 really takes effect, it is going to be a game changer for a lot of folks. Thats because even if you’re not one of the people who can take advantage of the new rules, it’s going to impact our market in a big way. To get an overview about how it’s going to affect you, watch my video and read my overview of the new, special rules below.
Quick Disclaimer: always make sure that you go talk to your real estate attorney and/or your CPA before you make any final decisions on your estate, your real estate property or your tax situation.
Who are the eligible homeowners?
Prop 19 is an extension of the rules from Prop 13. Prop 13 allowed eligible participants who are over the age of 55, severely disabled or displaced from their home from a wildfire, or other natural disasters, to transfer the tax basis of their primary residence into a new home of equal or lesser value one time in their life. The problem is, there was only about 10 counties in California that participated. For example, Alameda County did, Contra Costa didn’t. Enter Prop 19 and some new expanded rules.
California Proposition 19 allows eligible homeowners to move anywhere in the state.
With Prop 19, eligible homeowners are now allowed to go to any county in the entire state. They will then be allowed to take their old tax basis and keep in paying old tax rates on a new home of equal or lesser value.
Since about 30% of the people who are selling homes in the state of California right now are leaving the state entirely like I’ve talked about in another video, it will be very interesting to watch if these new rules will be able to change that trend.
California Proposition 19 allows eligible homeowners to use special rules three times in their lifetime
Previously with Prop 13, eligible homeowners are only allowed to take advantage of the special rules one time. Consequently, that brought some challenges with it. For example, if someone takes it but then remarries to someone who hasn’t, the combined entity of the marriage now kind of losses the privileges. There were a lot of loopholes then that made it less effective. However, with Prop 19, homeowners are now allowed to do this transfer of tax bases up to three times in their life time.
Eligible homeowners could use the special rules to move to a more expensive home
Another great part of Prop 19 is you can now buy properties that are actually more expensive than your previous residence. There is a give and take aspect with inherited properties which we will also talk about but let’s look at some quick examples first.
- Example no. 1: Let’s just say you had a $500,000 tax basis on your property that you live in now. Let’s say you can sell that property for a $1,000,000. If you then go buy a new property for a million dollars or less, you are allowed to take that old $500,000 tax basis and transfer it to your new property. Therefore, you can have a new $1M property but only pay taxes on $500,000.
- Example no. 2: If in that same example as the first one, what you bought instead is a home that’s worth more than $1M? Before, your tax basis reset to the purchase price of the property. Not anymore! Lets say you buy a new home for $1,100,000, and you sold your old home for $1,000,000. You now have a difference of $100k. Simply, the difference will be added to your original tax basis. Therefore add the excess amount of $100k will be added to your old tax basis of $500k. So you’re now paying taxes on $600,000, as opposed to the full $1.1 million that you would have been paying under Prop 13.
For inherited properties, unless the heir actually lives in it, the tax basis will be reassessed
Like any other law or proposition there is a give and take. We just talked about the give, now we will discuss the take.
Let’s say with our original example, you have a property that’s worth a $1,000,000, but has a basis on it a $500,000. In the past, if someone passed that to their kids or grandkids, the heir would inherit a million dollar property, but still also pay taxes on $500,000. Now, with Prop 19, unless the kid or the grandkid intends to move into the property as the purposes of primary residence, (and does so within 1 year of the transfer) it’s going to be automatically reassessed at market value. So inherited rental properties and vacation homes will definitely get pulled into this.
Heirs who live in the property will also be taxed if the current property value exceeds the original basis by more than $1M
In the event that a heir does move in to a property they inherited, there are still new rules applicable, depending if the property’s current value is worth over a million dollars more than its tax basis.
So going back to our original example of a home with a basis of $500,000. Let’s say there’s a property that’s currently worth $1,200,000. In this case, this property is not a million over the tax basis, so the $500,000 value still applies.
But let’s say the inherited property is worth $1,600,000. So you can apply the $1,000,000 buffer to the $500,000 basis, which gets you to $1,500,000. Unfortunately, that is less than the value of the home. So you’ve got $100,000 in more than what is allowed. That $100,000 will be added to the original tax basis ultimately bringing the homes basis up to $600,000.
A few more things to note: starting in February 2023, that $1,000,000 buffer will increase based on the house price index for that year for every few years. So it’ll start to increase as prices go up. Secondly, if you’re going to inherit one of these properties, you also have to move into it within one year of the transfer. Otherwise, there will be an automatic reassessment. Lastly, to take advantage of this new tax law, parents can sell their property to their child, but in the case of grandparents, they have to actually pass away for the property to be eligible for this formula.
Key Dates to Remember
- February 23, 2021
This is when the inner-family transfer from parent to child, or grandparent grandchild take effect. Before that, it’s likely going to be business as usual.
- April 16 2021
This is when all the other special rules we’ve talked about above, will take effect. So make sure to remember this date and talk to your real estate attorney or CPA before you go and make any decisions on your property.
California Proposition 19 Summary of Takeaways
- Eligible homeowners will be able to move anywhere in the state.
- They can buy a larger/more expensive property that might meet their needs better than where they’re living in currently.
- Eligible homeowners can use special rules three times.
- If you inherited a property, you have to actually live as your primary residence to take advantage of the original tax basis. If you don’t do that, (example: investment property or a vacation home) , you might end up having to pay a pretty substantial amount of taxes. This is interesting for the secondary second home markets, rental markets and areas where retirees might go.
- Lastly, people have to figure out a lot of new workarounds and strategies for their estate planning. So if these rules affect you, again, make sure you talk to your CPA, your attorney, whoever to make sure you get the final details on it.
I hope my video and blog about California Proposition 19 has helped you.
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