For most people, their home is one of their largest financial assets.
As parents age, many contemplate transferring the title of their home to their children while they are alive, rather than waiting until they pass away. There is an impression they can use a simple “quitclaim” deed to complete the transfer and that’s it. As the adage goes: If it sounds too good to be true, it probably is.
On November 3, 2020, California voters approved Proposition 19, the Home Protection for Seniors, Severely Disabled, Families and Victims of Wildfire or Natural Disasters Act. Proposition 19 is a constitutional amendment that limits people who inherit family properties from keeping the low property tax base unless they use the home as their own primary residence, but it also allows homeowners who are over 55 years of age, disabled, or victims of a wildfire or natural disaster to transfer the assessed value of their primary residence to a newly purchased or newly constructed replacement residence, as many as three transfers allowed during their lifetime.
The law changes two existing statewide property-tax savings programs:
- Limits parent-and-child transfer and grandparent-to-grandchild transfer exclusions. This became effective February 16, 2021.
- Replaces programs for home transfer by seniors and severely disabled persons. This became effective April 1, 2021.
Parent-to-child and grandparent-to-grandchild transfers have changed. Under Proposition 19 there are fewer tax savings opportunities. On the other hand, replacement home transfers for seniors and severely disabled persons allow for more flexibility.
The Office of the Assessor-Recorder for the City and County of San Francisco has an “About Proposition 19 (2020)” section summarizing the differences between the previous law and the changes made by Proposition 19.
About Proposition 13
In 1978 Proposition 13 was passed in California, largely due to concerns that soaring property values were affecting significant increases in property taxes. The aging population was faced with not being able to move or downsize their homes because it would drastically increase their property taxes. Additionally, those that inherited a property from their parents were forced to sell the home because the value of the property would be reassessed to market value at the time of transfer and therefore the property taxes would significantly increase. For many, Proposition 13 was a welcome relief by freezing the property tax base of their homes and thereby limiting annual increases in property taxes.
Proposition 13 allows a transfer of primary resident between parent and child without reassessing the tax base of the home. To get the benefit, you filed the appropriate form with your county assessor’s office after you prepared and filed the deed transferring the property from a parent to a child. The parent/child exclusion is available whether you transfer your primary resident to your child during your lifetime or after the passing of a parent.
For example, say you purchased your home for $50,000 and it is worth $700,000 at the time of transfer. It is possible for a child to inherit their parent’s home with a step-up in basis of $700,000, while paying property taxes for a property valued at approximately $50,000.
One other benefit provided under Proposition 13 is for those over age 55, someone with a severe disability, or whose property has been impacted by a natural disaster. They can sell their primary residence, and — as long as they acquired a replacement principal residence that was equal or lesser current market value and located in the same county — they’re able to transfer the base year value of their old residence over to the new residence.
Both Propositions 13 and 19 have many nuances that must be followed for your strategy to work — it’s always advisable to work with an attorney that practices in this area to help you navigate the complexities.
Considerations for gifting your child a home
Here are some additional things you should know:
Carryover basis vs. step-up in basis: California does allow you to transfer property to your children with a quitclaim deed, but doing so can adversely affect your child’s tax situation if they ever want to sell the property. If you give your child your house during your lifetime, he/she will get your home with the same cost basis as you purchased the home.
Again, say you purchased your home for $50,000, and the home is worth $700,000 at the time of the transfer. Your child will get the same basis in the house as you purchased, i.e., $50,000 (this is known as the carryover basis). When your child sells the house shortly after, he/she will pay a capital gains tax on the difference between the original basis $50,000 and the sale price, $700,000. However, if your child inherits the property at the time of your death, generally the basis would be the value of the house when you died (this is known as the stepped-up basis).
Using the same example, if your child inherits the property and sells it shortly thereafter, and the value of the property is $700,000 at the time of your death, he/she will have a tax basis (stepped-up) of $700,000 and therefore will have zero capital gains and therefore no tax liability.
Gift taxes: When you make a gift to a child for an amount that exceeds the annual gift tax exclusion (for 2022, $16,000 per person, $32,000 per couple), you will need to file a gift tax return (Form 709). On the gift tax return, you can choose to either pay a gift tax on the amount of the transfer, or instead, use some of your lifetime exclusion (for 2022, $12,600,000 per person).
For example, a widow wants to gift her son her primary home that’s worth $700,000. On her gift tax return, she could exclude $15,000 from gift taxes using her annual exclusion ($700,000 – $16,000 = $684,000). For the remainder amount of $684,000, she can choose to pay the gift tax currently, or deduct this amount from her lifetime exclusion ($12,600,000 – $684,000).
Losing control: Another reason for parents to not transfer their home to their children during their lifetime is that once a parent gifts the assets to the child, it becomes the child’s property. As such, if the child wants to take a mortgage on the property, sell it or kick the parents out, nothing is stopping the child from doing so. Even scarier, the child could be subject to creditor issues, a divorce or accident and the house could fall into the hands of a creditor or judgement from a lawsuit.
As you can see, there are many things to consider when thinking about your California property. Hiring the right professional can help you with an appropriate strategy for estate planning for you and your family.