Steve Welty

Issue# 26

December 2024

Dear Clients and Friends,

If you plan to pass a rental property down to your children, or if your parents own a rental property that you might inherit one day, it’s important to understand Proposition 19. Although this law passed a few years ago, we still receive many questions about its implications.

Let’s dig into the key details and my take on how to plan effectively.

What You Need to Know About Prop 19

Reassessment to Market Value: If your kids don’t use the inherited property as their primary residence within one year, the property will be reassessed at current market value, resulting in a much higher property tax bill. This can force them to sell if they can’t afford the new taxes.

Exclusion Cap: Even if they move in, only your assessed value plus $1 million is excluded from reassessment. Anything beyond that threshold is taxed at today’s market rates.

My Take: For most of us in California’s market, $1 million doesn’t cover much. In areas like San Diego or Orange County, that cap is quickly surpassed, making it hard for families to hold onto generational assets.

What About Prop 19 and Housing Providers?

One notable aspect of Prop 19 is the ability for homeowners aged 55 and older to transfer the taxable value of their primary residence to a replacement home anywhere in California. This benefit can be utilized up to three times.

However, this advantage does not extend to rental property landlords. For rental properties, the tax basis cannot be transferred to a new property. Additionally, when rental properties are inherited, they are generally subject to reassessment at current market value unless the inheriting child uses the property as their primary residence.

For housing providers, this means higher property taxes on inherited rental properties, making it essential to explore other strategies to mitigate these impacts.

Tax Planning Strategies Can Help

Gradual Ownership Transfers Through LLCs: Using Family LLCs, you can slowly shift ownership over time, potentially avoiding reassessment. It’s not a quick fix and requires expert guidance, but it’s a tool I’ve seen work well.

Trust Planning: Certain types of trusts may help mitigate the tax impacts of Prop 19. While they’re not a silver bullet, they can be part of a broader plan.

Act Early: Timing is critical. If transferring property is on your radar, the sooner you start planning, the more options you’ll have. Procrastination can limit your flexibility.

Silver Linings for Inherited Property

Despite the challenges, one significant advantage remains: stepped-up basis for federal capital gains tax purposes. If your heirs sell the property, the tax is calculated based on its value at the time of inheritance, not what you originally paid.

Example:

Your Assessed Value: $300,000

Current Market Value: $3 million
Result: $2.7M in equity is shielded from capital gains taxes, potentially saving your heirs hundreds of thousands of dollars.

Disclaimer: This newsletter is for informational purposes only and does not constitute legal or tax advice. Please consult with a professional advisor for advice specific to your situation.

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