Check Our Prop 19 Tax Increase Discussion On Tuesday Dec 22 (Full Video):
I have been to several Proposition 19 seminars. I have read everything about Proposition 19 that I could lay my hands on.
There is still uncertainty about what will work…and may not work…to combat the effect and impact of Proposition 19. Not even the Los Angeles County Head Assessor Guy is certain about what will work to “get around” Proposition 19 with any certainty. On December 17th, I attended a zoom seminar held by the Head Assessor Guy (Jeff Prang) and his staff. As nice as they are, they could not answer a lot of questions. The answer to most of our inquiries about our proposed “get-around-plans” was something to the effect of this: “We can’t give you direction until “clean-up legislation” from the California Legislature and/or the Board of Equalization comes down”.
But…one thing that is VERY CLEAR! Based on what we know right now…the “battle plans” to get around the pernicious property-tax raising impact of Proposition 19 MUST BE IN PLACE AND COMPLETED PRIOR TO FEBRUARY 16, 2021. Actually, if that plan involves recording a deed with the Los Angeles County Recorder…then that “battle plan’ should REALLY be in place and completed by mid-to-late January…because the County Recorder will be snowed under due to the crush of deeds being recorded as part of those “battle plans”.
Let’s get basic!
Right now…when a parent dies and that parent’s home goes to his child…there is no property tax reassessment.
And right now…when a parent dies and that parent’s non-residence (apartment building, commercial property, whatever) goes to his child…there is no property tax reassessment on the first $1 million of assessed value. (Assessed value is NOT fair market value. Look at your property tax bill. You will see the assessed value which is likely really low…depending on when you obtained that non-residential property.)
Proposition 19 changed that. BIG TIME!
STARTING FEBRUARY 16, 2021…after-death transfers of real property between parent and child will result in a full property tax reassessment to the FAIR MARKET VALUE of that property. (The fair market value is determined by the Assessor who actually sends appraisers out to the property to inspect it.)
There is a exception to this reassessment. But I doubt if a lot of people will qualify for it. That exception is this: IF AT THE PARENT’S DEATH the property is the parent’s principal residence…and IF AFTER THE PARENT’S DEATH the child uses it as his principal residence…and IF the property’s fair market value AT THE PARENT’S DEATH is less than it’s assessed value…and IF THAT FAIR MARKET VALUE IS LESS THAN $1 MILLION… no reassessment.
BUT…if the property’s fair market value is MORE than $1 million over its assessed value…only the first $1 million plus the assessed value is excluded from property tax reassessment. Actually, this is a seriously-complicated math exercise that goes way beyond this over-simplified explanation. But trust me…if your house has insanely appreciated since you’ve owned it…it’s not much of a property tax discount.
That’s it. That’s the only exception.
(By the way…if your child does not live in your home after your death…but STILL takes the position that he is using it as his principal residence…how will the Assessor know that your child is lying? Two things. One…your child signs a document under penalty of perjury stating that the house is his principal residence. Two…your child should never %&* with the Assessor…because the Assessor ALWAYS finds out the truth.).
(Also…another question that comes up is: “How soon does the child have to move into the house in order for him to take the position that it is his principal residence?” The answer is: ONE YEAR AFTER YOUR DEATH.)
If you bought your house a million years ago…your assessed value is probably very low. So…even if your child lives in your home after you die…that will STILL result in a massive reassessment.
So…what is your reaction? Likely…it is the same reaction that most people have… which is: “Where’s the deed I can sign to give my kids now my house before February 16th kicks in”?
Certainly…signing that deed and recording it timely will solve the problem. But…giving away your house now with that deed will create another problem. It’s called “loss-of-stepped-up-income-tax-basis”.
What is “loss-of-stepped-up-income-tax-basis”? Well…”income tax basis” gets involved when you sell your house to determine your profit on that sale. Your “basis” in your house is what you paid for your house. If you bought your property many years ago…your basis is likely very low. So…if you sell your house for big dollars because of massive value appreciation….then you have made a huge profit which is determined by the difference between the SALE PRICE and the BASIS. And with that huge profit comes a huge capital gain tax. Between federal and state…that capital gain tax could be perhaps 35% of the profit. Not a small thing.
Here’s the thing. If you give your house now to your child…you also give him that property’s very low income tax basis. So if your child later sells that house…he will get stuck with that huge profit…and will have to pay that huge capital gains tax. BUT…if your child inherits the house from you after your death…he gets that house with a “stepped-up” income tax basis. (Meaning, stepped-up to that house’s fair market value as of the date of your death.)
So…see what I mean? If you give your house to your child now…that property will not get that “stepped-up-income-tax-basis” on your death.
So…what to do? Give your house to your child before February 16th which will keep the property taxes low but lose the “on-death-stepped-up-basis”? Or have your child inherit your house which will increase the property taxes but keep the “on-death-stepped up-basis”?
Well…maybe you know your child will never sell it. If your child never sells it…there will never be a capital gain tax on that sale. Of course, things happen where your child may have to sell, yes? Or…maybe you think, “Capital gains taxes on sale are a maybe…but property taxes are forever”. So…with that philosophy of the property tax reassessment being the lesser of the two evils…you give your house to your child prior to February 16th and say, “If my kid is stupid enough to sell it after I die when he knows the capital gains tax will be huge, that’s his problem”.
So…that’s the problem with giving away your house now to your child. It’s the loss of “on-death-stepped up-basis”. There is another problem…but not as compelling. If you give your house now to your child, and if you are rich enough…you may have to pay a Gift Tax. Right now…you can give up to $11.5 million of assets to anyone you want without you having to pay a gift tax. That’s a big gift tax exemption! But…if that gift tax exemption goes lower (say…to $3.5 million) because Georgia votes for two Democratic Senators…then there may be a gift tax on the value of the house that exceeds that gift tax exemption.
Oh! And here’s another more obvious problem with giving your property now. Giving away your house to your child puts your house in your child’s hands. Do you want to put the place you make your home into the hands of your child? Because if you do…your house now becomes subject to your child’s problems. Divorce. Financial immaturity. Transferring to the new “love of his life”. Bankruptcy. Creditors. Medical problems with insufficient insurance. All of those risks in your child’s life.
But…if you are hell-bent on making sure your property taxes on the property not go up when your house is in your child’s hands…then you will set aside those risks and do a quick-and-easy property transfer by signing a deed to your house over to your child and having it recorded prior to February 16th.
There is also another method to do that property transfer that can have the effect of (a) having your house transferred to your child before February 16th while (a) perhaps maintaining the “stepped-up-on-death-income-tax-basis” and (c) protecting your house from your child’s problems and risks of life. This method…which has to be in place before February 16th…involves the following:
*You establishing an irrevocable trust. This is called an “Irrevocable Incomplete Gift Trust”. This is when you sign an instrument which says that you no longer own the property. Who owns it? The irrevocable Incomplete Gift Trust owns it.
*You transfer the house to that Incomplete irrevocable Gift Trust. So…the record title to your house will not be in the name of your child (or other 3rd person) as the manager (Trustee).
*The Incomplete irrevocable Gift Trust says that your child owns the house But…until then…your child has limits what he can do with it. In other words…your child just can’t sell it out from under you or allow your child’s creditors to pay off his debts.
*The Irrevocable Trust does NOT give you the right to utilize the house as your residence. But…in a side agreement, the one in charge (the Trustee) and you will have agreed to allow you to rent the house for your residence at a nominal amount. So…if the fair rental value of the house is $6,000.00 monthly…the nominal rent would be, say, $500.00 monthly.
There is, obviously some detail I am skipping. But…for purposes of explaining this to non-lawyers…this is the “device” that will likely work to (a) cause a change in ownership of the house from you (the parent) to your child while we still are living in our pre-February 16th world of a parent-to-child reassessment exclusion; and (b) preserving the “stepped-up-on-death” income tax basis of the house.
What I said for the pre-February 16th planning of the transfer of your house…goes as well for the transfer of your real property OTHER than your house. You can use the Incomplete Irrevocable Gift Trust for your income-producing property (apartment, commercial property) to have your transfer of that property qualify for the parent-to-child reassessment exclusion. But…this plan for income-producing property MAY INVOLVE that you are no longer entitled to that property’s income which MAY have to go to the Incomplete Irrevocable Gift Trust. If you need that income…this plan may not be appropriate for you. And I would agree with you. My philosophy is…never give away assets that you will miss…may miss…will need…or may need.
Besides the Incomplete Irrevocable Gift Trust…there is another method that can be used to prevent major property tax reassessment of your non-residential real property which involves the use of entity planning. Such as establishing an LLC (Limited Liability Corporation. You want to know what the “Big Boys” do to keep reassessment at a bare minimum? This is what they do.
With this method…which does not have to be done prior to February 16th…you establish an LLC. You then transfer title of your income-producing property to the LLC. You own all the membership share of your LLC.
Then…about a year later…you assign 49% of your membership shares to your child. This will not trigger any reassessment. But…it does mean that you will not get that 49% of the income. So…if you need that 49% income…this is not the solution for you. But…let’s move on….
Then…about another year later…you dissolve the LLC and transfer 51% of the income-producing property to yourself and 49% of the income-producing property to your child.
Then…about a year later…you transfer 2% of your share of the income-producing property to your child. Your child now owns 51% of the property…and you own 49% of the property. THIS TRANSFER WILL RESULT IN A PROPERTY TAX REASSESSMENT OF THAT 2%…BUT IT’S ONLY ON THAT 2% TRANSFER.
Then…about a year later…you establish a NEW entity (another LLC, a Family Limited Partnership) and you transfer your 49% share to the new entity and your child transfers his 51% to the new entity. You will own 49% of the shares…and your child will own 51% of the shares.
Then you die…and your inheritance plan leaves 49% of your shares to your child. The result is…no property tax reassessment when your 49% shares go to your child.
Why so much waiting to do this step-by-step process? Because otherwise…the Assessor will say, “Hey! This is really a step-transaction that is designed to avoid property tax reassessment. We should look at the form over substance and see that this is all one big scheme to cheat the system of no parent-to-child reassessment exclusion”. By waiting…you show the Assessor that each step is its own deal…and not part of one big plan to fool the Assessor.
I will now conclude this essay (treatise?) because… well…how much can you really withstand in one sitting? If you have any questions…please email me or call me. If I am super-busy (because I am fielding so many inquiries about this subject), keep trying. I promise I will get back to you.
Check Our Prop 19 Tax Increase Discussion On Tuesday Dec 22 (Full Video): https://www.facebook.com/events/430754084600476/