Proposition 19 was a highly contested ballot measure during the recent election, narrowly passing with 51% approval. The proposition was marketed as a solution to benefiting wildfire victims and the elderly. However, the proposition also rips away protections against property tax changes that California residents have enjoyed for almost forty years. Proposition 19 removes a parent or grandparent’s abilities and dreams of keeping their family homes for more than one generation.
Nevertheless, in this article, I will discuss some strategies after Proposition 19 which help to avoid property tax reassessment while still keeping ownership of family properties.
The Law Before Proposition 19
What exactly did Proposition 19 change? To understand this, you must understand Proposition 13, which was passed in 1978. Proposition 13 was a resounding effort from California citizens to initiate a “tax revolt”, and change the way in which California property tax was managed in order to benefit the citizens. Due to the inflation shocks in the 70’s, senior citizens were unable to pay their property taxes and were forced to sell their homes. The initiative had two main effects: it limited property taxes to 1% of the assessed value, and changed the process and reasons for which a house could be reassessed.
Prior to Proposition 13, property tax was up to the discretion of the overall market, meaning that if a home suddenly gained market value, its property tax would skyrocket, leaving the homeowner at risk of losing their home. Instead, the initiative limited the tax to just 1% of the home’s assessed value. The assessed value of a home is its purchase price, adjusted annually, not its current market value, and as such, two homes in the same area can have wildly different assessed values and property taxes depending on how long ago they were purchased. Proposition 13 even limited the amount that a home’s assessed value could increase to just 2% every year, meaning that property taxes themselves would only increase by that amount every year. Under Proposition 13, the only time a home’s assessed value is reset to market value is when it is sold or changed ownership, thus giving a long-time homeowner the security of a low and consistent property tax.
Proposition 13 worked in conjunction with Propositions 58 and 193, which were passed later to help protect not only homeowners, but their families as well. These two initiatives granted parents and grandparents the ability to pass their homes down to their children without triggering a reassessment, even though there was a change in ownership.
Take for example a home bought in 1970 for $200,000. This house would then have an assessed value of $200,000 as of 1970, and thus a property tax of around $2,000. Each year following, the assessed value would increase at a maximum rate of 2% annually, but no more. If the property was passed down to the children in the year 2000, when the market value of the home is closer to $2,000,000, the property tax may still be around $3,500 a year, even though a brand new home for $2,000,000 would cost about $20,000 in property taxes in year one alone, simply because the home was passed from parent to child.
Enter Proposition 19
So how does Proposition 19 apply to this scenario? Well, under Proposition 19, transfers between parents/grandparents and their children/grandchildren are no longer protected from reassessment if that transfer occurs after February 15, 2021. The proposition does give a limited exclusion for parent and child transfers, however it has strict requirements and a weak remedy for families. In order to qualify for the limited exception, the home must be classified as the “family home.” This means the parent(s) must claim the home as their primary residence at the time of the transfer and the child must also claim the home as their primary residence as well. If that is the case, and if the exemption is claimed within 1 year of the change in ownership, then the first $1 million is not reassessed, but everything over it will be.
For example, if a family home had an assessed value at the time of the transfer of $200,000, and if all the other criteria were satisfied, then the exemption would apply up to a fair market value of $1,200,000. However, if the new market value of the home is $2,000,000, then $800,000 would still be reassessed and this tax will be added to the tax on the original assessed value of $200,000. In this limited exception, the property tax would still increase, but “only” from $3,500 to $10,000.
What Can I Do Now?
So how can a family protect themselves and their children from the effects of Proposition 19? The best way to protect a non-primary home (e.g., a rental property) involves using an LLC (Limited Liability Company) as the owner of the property. The ideal scenario would be one in which the LLC is what is known as the “Original Owner” of the property. This means that the LLC was the owner of the property when it was first acquired and assessed, and thus qualifies to be the Original Owner. In such a case, it is possible that the property may never get reassessed even at death or any other transfer. This is because the home will never be reassessed so long as no one inherits and holds more than a 50% ownership in the company. So, if a person has two children they would like to pass a home down to, each child could each own 50% of the LLC and not trigger a reassessment, even under the new proposition, assuming the LLC was the Original Owner of the property.
Unfortunately, for a variety of reasons including those having to do with lending, many people will not be able to acquire a property in the name of an LLC as the Original Owner.
What can a person do if they must transfer the ownership into an LLC only after acquiring it? There are a couple of bright-line rules to understand when it comes to the reassessment of properties owned in a legal entity like an LLC: the proportional interest rule and the cumulative transfer rule.
The proportional interest rule is relatively simple. It states that in order to transfer ownership of a property into an LLC, the transferor and transferee must have the same proportional interest before and after the transfer. For example, if you own 100% of a home, seeking to move it into an LLC, then you must own 100% of the LLC shares in order to transfer the property without triggering a reassessment. The ownership of the property must exactly match the ownership of the LLC to avoid a reassessment, and vice versa.
The cumulative transfer rule states that after a property is moved into an LLC, you must be sure not to change the ownership of more than 50% of the membership interests of the LLC. This is a cumulative test throughout the life of the LLC. If more than 50% of the ownership of the LLC changes, and when it does, the entire property will be reassessed, not just a portion. While it is possible to use multiple LLCs and multiple transfers to avoid this issue, one must be very cautious to do so, as doing so may run afoul of the Step Transaction Doctrine, which a County Assessor may invoke. The Step Transaction Doctrine essentially posits that you cannot put extra or “pre-arranged” steps in the process of transferring a property simply to game the system and avoid a reassessment. There must be evidence for legitimate reasons for all actions taken (other than tax avoidance) in order to avoid the Step Transaction Doctrine, and this can be difficult for many people and practitioners to prove.
Overall, the best way to avoid a reassessment under Proposition 19 would be to have your future purchases acquired by an LLC as the original owner. This scenario is regarded as the “Golden Rule” of protecting against a reassessment, and has benefits from a variety of other standpoints as well.
Proposition 19 overturned nearly four decades of California property tax protections, and leaves an array of questions and concerns in its midst. While there are ways to get around it, it is always advisable to reach out to trusted legal counsel, and to be careful through the process, to avoid making the situation worse than it needs to be.