By Gina Gaudio-Grace, Platinum Trust Group
In November 2020, Californian voters passed Proposition 19, a State Constitutional Amendment, with 51.1% of the voters approving it. The new law goes into effect on February 16, 2021. This means that you have a short window of time to act under the existing law.
The Way We Were: How It Works Today
To understand the impact Proposition 19 will have on apartment owners, it is helpful to recognize that it modifies Proposition 13 (originally passed in 1978). Under Proposition 13, parents are permitted to transfer: (i) their primary residence, and (ii) up to $1 million in assessed value of other properties, to their children without triggering a reassessment for property tax purposes. This means that children can keep the low property tax assessment from their parents following a transfer of a primary residence or the first one million dollars of assessed value (which is usually substantially less than fair market value) of investment properties.
These same rules also apply if a grandparent transfers to a grandchild, provided the grandchild’s parents are deceased. Under Proposition 13, people over the age of 55 and people who are severely disabled can sell a primary residence and purchase a property of equal or lesser value and receive the same low property tax assessment they originally had in the property sold, provided however that the new property is in the same county as the original property.
What’s Changed With Proposition 19?
Proposition 19 has changed these rules in several ways. First, the exemption from reassessment for up to $1,000,000 in assessed value of property other than a primary residence transferred from parent to child or grandparent to grandchild will vanish completely. Second, while parents can still transfer their primary residence to their children, their children will only receive the lower assessed value if they utilize the property as their primary residence. Furthermore, if the property’s fair market value at the time of the transfer exceeds the parent’s assessed value by more than $1 million, the property will be partially reassessed. In other words, the passage of Proposition 19 is a huge property tax increase being placed on our descendants.
So, under Proposition 19, if a parent chooses to transfer their primary residence to their children during the parent’s lifetime, the children only enjoy the lower property taxes if they move into the home with their parents! This may not be practical, feasible, or desirable for many adult children who have families of their own to think of, or who have jobs in other areas away from their parents or even other states.
Be Careful: Mind Your Capital Gains Taxes
Some lawyers are advising clients to rush into transfers of primary residences and up to $1 million in assessed value of other real estate before the current Proposition 13 law vanishes entirely on February 15, 2021. While this solution preserves the lower property tax rate for the child receiving the property, it could create another issue for the child. If a parent transfers a property to a child at the time of the parent’s passing (whether through a Will or a Trust), the child receives a step-up in basis automatically. But if the parent makes an “inter vivos gift” to the child during the parent’s lifetime, the child will receive the real estate at the parent’s original basis.
This means that when the child decides to sell the property, the child will be responsible for capital gains taxes on the sale amount less the parent’s original basis. This could cost the child hundreds of thousands to millions of dollars in additional capital gains taxes. So, it may not be a good idea for parents and grandparents to rush into a transfer of property prior to the February 15, 2021 deadline without serious consideration of the ramifications of the transfer.
Here’s a Solution
So, how can Apartment Owners transfer their holdings to their heirs without triggering a reassessment and without making their heirs responsible for a mountain of capital gains taxes? The solution is to use a highly specialized type of Non-Grantor Trust that is not self-settled and that names the current owner as the Beneficiary (or one of several Beneficiaries). With this type of specialized Trust, the Trust is able to earn income from passive activities: the Trust owns rental property generates rent and lease income that is earned when the Apartment Building, Single-Family Residence, or Commercial Property) and, pursuant to section 643(b) of the Internal Revenue Code, defers the income tax liability in perpetuity — as long as the income is added to the corpus of the Trust (meaning it is not distributed to Beneficiaries), and as long as the Trustee uses his or her discretion to declare the income as an Extraordinary Dividend. (The Trustee can still use the income for the Trust’s benefit, for example, by buying other properties, lifestyle, etc.)
So, the current owner(s) of the property would have a Non-Grantor, Irrevocable, Discretionary Trust that is Not Self Settled established by a third-party Settlor, and have the Settlor name the current owner as a Beneficiary. The current owner would then sell the property to the Trust and record that sale with the county without triggering a reassessment under Proposition 19.
The current owner’s heirs can be added to the Trust at any time. With this type of Trust, the Trust maintains the ownership of the property at all times, causing the capital gains that occur on a future sale to a third party to belong to the Trust, not the heirs. Although the Trust has the same basis as the current owner(s), this causes no issues for the Trust because, under section 643(a)(3) of the Internal Revenue Code, if the capital gain is added to corpus and declared by the Trustee to be an Extraordinary Dividend, no capital gain occurs. This means that neither the heirs nor the Trust will have to pay capital gains taxes upon the sale of the property.
This highly specialized Trust is the subject of 58 copyrights and is proprietary to Platinum Trust Group. You can learn more about how it can help you mitigate taxes and have ironclad asset protection by watching the livestream replay at www.PlatinumTrustGroup.com/AAGLA.
Gina Gaudio-Grace, PhD, JD is a Retired Attorney, Graduate of Notre Dame Law School (1991), a former Lead Note Editor of the Notre Dame Law Review, and she holds a PhD in Entrepreneurship and Business Strategy. Ms. Gaudio-Grace is also the Operations Manager and Business Development Director of Platinum Trust Group. Gina and their team of Trust Advisors and Tax Professionals are available to consult with you to determine if this proprietary Trust is a fit for your needs.