Estate planning is a noble and generous act, allowing you to secure your property for your loved ones. However, many are unaware of the significant property taxes associated with inherited properties, which can sometimes force beneficiaries to give up their cherished inheritances. In California, new legislation has made this issue even more critical. Fortunately, estate planning can help you avoid a hefty property tax reassessment and ensure your property remains with your beneficiaries.
California Laws on Transferring Real Property
In California, property tax reassessment has a long history. Proposition 13, passed in 1978, aimed to limit property tax increases. It set the property tax rate at 1% of a property’s assessed value, with an annual increase cap of 2%.
However, Proposition 19, which was approved more recently, brought significant changes. It limits property tax reassessment exemptions for inherited properties. In the past, children or grandchildren could inherit property without a tax reassessment. Now, if the property isn’t used as the beneficiary’s primary residence, it may lead to higher property taxes.
If the transfer does meet the rules for the primary residence, the child’s tax value depends on whether the property’s value at the time of the transfer is higher than the parent’s value by over $1 million.
- If the property’s value at the time of the transfer is less than $1 million more than the parent’s value, the child keeps the parent’s current tax value.
- If the property’s value at the time of the transfer is over $1 million more than the parent’s value, the child’s tax value is the property’s current value minus $1 million. This rule only applies if it’s the child’s primary residence.
Property Tax Reassessment Example
To understand the impact, let us consider an example. Say you bought a commercial building in 1988 for $500,000. Now, it’s worth around $4,000,000, but the current tax value is $1,000,000. So, you pay about $12,500 in property taxes each year based on this lower value.
If you passed away this year, the property taxes would skyrocket to about $50,000 a year, which is $37,500 more. This sudden and significant increase could force your children or beneficiaries to sell the property.
Property Tax Reassessment Exclusions
Fortunately, some exclusions remain. Property tax reassessment is automatically avoided in various scenarios, such as transfers between spouses or registered domestic partners, provided specific requirements are met:
- When using a trust under certain qualifications.
- Adding a spouse or partner to the title.
- Transferring upon death.
- During divorce or partnership termination.
For instance, if you’re married and want to add your spouse to a home title, there won’t be a property tax increase. If one of you passes away, the surviving spouse can inherit their share without triggering reassessment.
Property transfers solely to change title holding methods are also allowed. This can involve transfers between an individual and a legal entity or between entities. Ownership proportions must remain the same. If you jointly own a property and wish to transfer it to an LLC for liability protection, reassessment will not happen if each individual still owns 50% of the LLC. However, if the original LLC owners transfer over 50% cumulatively to anyone else, the entire property undergoes reassessment.
You can also receive a reassessment exclusion when:
- Correcting a name on the title, like a name change upon marriage.
- Changing the title related to a lender’s security interest or for financing purposes.
- Altering the trust’s trustee.
- Transferring property into or out of a revocable living trust, so long as the trustor and deed grantor are the same.
- Refinancing, as long as the title remains the same.
- Routine maintenance or repairs to the property like a new roof or plumbing won’t lead to reassessment.
- Retrofitting for earthquake safety, soundproofing, or accommodating a disabled person won’t cause reassessment.
- Adding Joint Tenants, whether related or not.
- Buying a replacement home – Proposition 19 has made it easier for older homeowners to transfer their property tax assessments to a new home. Starting from April 1, 2021, Californians aged 55 and above can move anywhere within the state and carry their original Proposition 13 tax assessment to a new home. This new home can be of equal or lesser value, or even more expensive, with a tax adjustment in the latter case. You have the flexibility to do this up to three times during your lifetime.
Furthermore, Proposition 19 extends this exception to individuals with significant disabilities or those who have suffered from natural disasters like the wildfires and floods that have affected many Californians.
Transfers that Will Trigger Property Tax Reassessment
- Change in Ownership, for instance, through a purchase.
- Transfers among friends or family that don’t involve a child’s primary residence.
- Completion of new construction, including new buildings or extensions.
- An addition to a home increases the assessment only by the value of the new construction, not the existing home.
- A property tax increase occurs with a remodel when it involves adding new square footage or significant new improvements, like a spa or swimming pool. A complete kitchen or bathroom remodel with upgraded fixtures and appliances will also result in an increased assessed value.
Property tax reassessment can be a significant financial burden for beneficiaries. However, with the right estate planning strategies, you can help protect your property and keep it within your family without the worry of increased taxes. To navigate these complex laws and ensure your estate plan is tax-efficient, consider working with experienced professionals like Hermance Law. Protect your loved ones’ future by safeguarding your property and your legacy. Contact us to get started on your estate planning journey today.