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California Tax Changes to Parent-Child Exclusion

January 4, 2021
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California recently passed Proposition 19 (Prop.19) which contains two important changes in California property tax assessments that may impact your estate planning.

Changes to the Parent-Child Exclusion - Principal Residence

Prop. 19 limits the availability of the parent-child exclusion for purposes of real estate tax assessments. This change is set to take effect on February 16, 2021.

Under California law, before February 16, 2021, when a parent transfers ownership of his or her principal residence to a child, whether by sale, gift, or inheritance the property's value for property tax assessment purposes is not reassessed, regardless of how the child uses the residence.

After February 16, 2021, Prop. 19 changes this by requiring that the transferor child uses this transferred residence as their own principal residence in order to apply for the property tax reassessment exclusion. Furthermore, even if the child uses the residence as his or her own, the available exclusion is limited to the first $1,000,000 of fair market value (FMV).

Families with real estate that are planning to pass from parent to child may want to make transfers before February 16, 2021 to preserve the lower property tax base. 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 are likely to sell the property, consider that making a lifetime gift will preserve the property tax base, but it will eliminate the step-up in basis that the children would get if they inherit at their parent’s death.

The following issues remain unclear until further guidance is provided:

  • The transferee children are required to use the property as their own principal residence and are required to claim the homeowner’s exemption at the time of the transfer, or no later than one year after the date of transfer. However, for transfers that vest immediately upon the death of a parent such as with an intentionally defective grantor trust, it is unclear whether the clock for filing the homeowner’s exemption claim starts to run upon the death of a parent or on the recording of a deed; and
  • In some cases, parents gift their principal residence to multiple children. This presents no issue under current law since there’s no requirement that the children reside in the property. Under Prop. 19, however, it is not clear whether these transfers would continue to qualify for the parent - child exclusion, since in most cases, only one child would use the property as their own principal residence.

Changes to the Parent-Child Exclusion – Non- Principal Residence

After February 16, 2021, Prop. 19 eliminates the non-principal residence exclusion completely. Currently, under California law, there is an allowable lifetime exclusion of $1 million ($2 million for a married couple) of assessed value of non-principal residence properties (e.g. second homes, rental properties, commercial properties, etc.) without triggering a reassessment. This exclusion is based on the current assessed value, which can often be lower than the current fair market value.

Base-year Transfers

For transfers on or after April 1, 2021, Prop. 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. 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.

If you have any questions about these tax changes or how we can help, please reach out to your Citrin Cooperman tax advisor.

Laura Stone, CPA
Partner
lstone@citrincooperman.com
Richard Dettorre, CPA
Partner
rdetorre@citrincooperman.com
Susan Jacobson, CPA, MST
Director
sjacobson@citrincooperman.com