By Mary Korkodian & Brad N. Baker

For California properties, property tax planning was and remains of tremendous import. However, it was the often-overlooked child in the estate planning world until the passing of Proposition 19. With so many negatively impacted by Proposition 19, more people are beginning to focus their attention on property tax planning for their children.

Background Of Proposition 13

Proposition 13, which went into effect in the late 1970s, limits the increase in property taxes to 2% increase per year.  Thus, property taxes are often based on “assessed” values that are but a small fraction of the “fair market” value. This has been a savior for most Californians, especially for senior citizens who would have lost their homes as a result of property taxes ballooning as property values greatly increased.  

Are There Reassessment Exclusions Available

Property taxes are reassessed when there is a change in ownership. However, there are a few exclusions to avoid such reassessment. The most often used exclusions are the parent-child exclusion and interspousal exclusion.  

After the passing of Prop 19, the parent-child exclusion is far more limited than it once was. Because of Prop 19, as of February 16, 2021, the parent-child exclusion is available only for principal residences and only up to an additional $1 million in assessed value.

If you are using the parent-child exclusion and only have one child, then it is pretty hard to goof things up.  (I guess the same could be said if you only have one spouse!)  However, when there are multiple children, there are some traps for the unwary. It is in these situations that property tax planning can be very valuable.

Multiple Children Scenarios

Often, parents will have their estate plans set up to have trust assets split equally among all their children. However, when there are multiple children and only one of the children intends to use the property as his/her principal residence, we would advise NOT splitting the ownership equally between the children. Why? Because under Prop 19, only the child using the property as his/her principal residence qualifies for the parent-child exclusion, and therefore, the property will be partially reassessed.

For example, if there are three children, one child may decide to use the property as his/her principal residence and the other two children may not wish to do the same. (It’s unlikely all three children will want to live together in the same property!) If the property is left to all three children, only the child using the property as his/her principal residence qualifies for the parent-child exclusion (thus, 1/3 qualifies for the parent-child exclusion), leaving 2/3 of the property to be reassessed. When that happens, the child who maintains the property as his/her principal ownership will be stuck with thousands of dollars per year in additional property taxes due to the 2/3 reassessment. Thus, it is prudent, now more than ever, to consider property tax planning.

Solutions For Multiple Children Scenarios

For parents with substantial assets, it is very easy to allocate 100% of the property to one child and give equivalent assets to the other children.

However, for parents of very modest means whose only asset is the family residence, giving one child 100% of the property and providing equivalent assets to the other children may not be feasible. In that case, giving the children the “option” to buy the residence could be the solution. This allows conventional financing and/or assets outside the trust to be used to equalize distributions among the children.

For those parents who did not provide their children with the option to purchase the family residence, there is another way to possibly preserve the low property tax base.  It does not work in all instances, but if the planets line up properly, the trustee can “borrow” money against the property while the property is still in the trust to lower the equity and provide cash to distribute to the sibling(s) who are not receiving any portion of the residence.  Caveat:  The borrowing must be done by the trustee within the trust structure prior to distribution, and family members cannot be the lender.  Working with an attorney is particularly advisable in these situations.

Important Note: For those fortunate enough to have had the value of the principal residence increase by more than $1 Million since it was purchased, Proposition 19 might cause the property taxes to increase upon transfer. Prior to Prop 19, a parent could transfer a principal residence with unlimited value to a child and avoid reassessment. After Prop 19, only an additional $1 Million of assessed value is excluded from reassessment for a principal residence, and all investment properties, vacation homes, and second homes within California get completed reassessed when passing to non-spouses.

The Key To Property Tax Planning

Property tax planning is less difficult if the issue is on everyone’s plate. Plan ahead so your children do not lose the precious asset of low property taxes.

Please Note: This document does not constitute legal advice. Please consult an attorney for legal advice on what to do in a particular situation.