Irrevocable Trusts and Parent to Child Property Tax Transfers
Positive Property Tax Relief Changes for California Families
California homeowners over the age of 55 or with severe disabilities (which is still not defined as to what the exact definition of “severe” is) will have the ability to transfer their current property tax assessed value (i.e., “base year value transfer”) of their primary residence to another primary residence anywhere in California.
Therefore, various expanded property tax exclusions have become available to Californians in all 58 counties in the state – to get approved for a base year value transfer. Other new property tax relief breaks in California include tax relief opportunities for homeowners badly impacted by wildfire or other natural disasters.
Of course to take advantage of a parent-child exclusion, inheriting property taxes in California through a property tax transfer with the right to keep parents property taxes basically forever… one has to be inheriting a home used as a primary residence by parents, and must move in within a year also as a primary residence. But that’s hopefully a small price for families to pay to avoid property tax reassessment, to continue inheriting property taxes in California, which otherwise would be financially crippling for most middle class and upper middle class Californians.
How Do CA Families Take Advantage of an Irrevocable Trust?
Simply stated, an irrevocable trust is a trust that features terms and conditions that can’t be revised. This is quite different than a revocable trust, which permits a grantor to revise a trust, and to take property back whenever one wishes.
However, California families can use an irrevocable trust not only to list beneficiaries for a trustee, but also define assets that are to be inherited, by exactly whom, and what the timeline of each inherited asset is to be… Along with the Proposition 58 originated ability to execute a buyout of inherited property from co-beneficiaries looking to sell – to beneficiaries looking to buy them out…
This usually takes place with the help of an experienced trust & estate lender, such as Commercial Loan Corp in Newport Beach, and most likely a law firm experienced in Proposition 19 and property tax relief matters, such as the well respected and well known firm Cunningham Legal in Pasadena – who can also draft an irrevocable trust, and advise a family in naming an appropriate trustee, who is both honest and committed to the trust agreement and it’s benefit to the family being served.
The family-trustee relationship going forward does not always work out in perfect terms, however these are the noted and generally accepted objectives for both family and trustee.
The Family’s Trustee
As you probably already know, a trustee is required to act in the best interest of the trust beneficiaries and implement inheritance distributions to all trust beneficiaries according to the terms of the trust, whether they get along or not… and they often do not. But the trustee must understand that he or she is there to serve the beneficiaries and the trust — not themselves. Many trustees miss that fact, and must be reminded of this repeatedly sometimes, until it sinks in.
All family members work with their trustee to utilize Proposition 19 in concert with an irrevocable trust loan to minimize property reassessment and estate tax, to protect assets from creditors… and to keep under-age or special needs family members far away from legal and/or financial responsibility.
Protecting the Family From Creditors and Tax Hikes
Setting up an irrevocable trust, working with an irrevocable trust lender can help take advantage of the significant estate tax savings this sort of trust provides. An irrevocable trust also furnishes meaningful protection from creditors. As soon as assets and real property transfer to an irrevocable trust, they no longer are property of a grantor – who generally are parents of the grantees, or beneficiaries – and these assets now become legal property of the trustee to hold in safe-keeping to later distribute to the beneficiaries – who are typically family members.
So future creditors can’t place a lien on assets transferred to the trust because those assets no longer belong to the grantor (often the parent or parents). Creditors of beneficiaries generally can’t place a lien against trust assets until those assets are distributed to the beneficiaries, often the grown children of the deceased parents. So these trust protections are certainly worth examining carefully and discussing with your attorney, as are all new rules for property tax transfers in California.
Despite confusing, often deceptive messaging, designed at all costs to get Proposition 19 voted into law in The Golden State of California – it’s clear to most Californians that Proposition 19 property tax breaks really will increase property tax relief measures for homeowners over age 55, plus add exclusions from property taxes for homeowners who are victims of wild-fires and other natural disasters – plus homeowners who are seriously disabled.
Despite a little juggling with the facts, the slick promotion to get this tax measure voted into law, with attractive promises of improved tax exemptions… it did in fact appear to be a legitimate, believable package of property tax relief benefits for residents of the state of California — as long as you ignored the fine print.
What used to be Proposition 60 (voted into law in 1986, the same year Proposition 58 was passed), helped homeowners over 55 to sell their house and move into another home valuated at the same amount or less – in the same county – maintaining a low property tax base… This has been rolled into Proposition 19, and can be taken at face value… as long as the California State Board of Equalization (BOE) continues to function as a non-political, fact-based source of CA property tax info – which, according to experts and state economists, it does appear to be doing.
Experts Weight in on Proposition 19
Gaye Chun, the City National Bank wealth planner confirms, telling us: “The idea was to make it easier for seniors to move without worrying about a huge jump in their property tax bill that might be difficult for them to pay.”
Bruce M. Macdonald, an attorney with Carico Macdonald Kil & Benz LLP in El Segundo, CA agrees, stating, “If someone over 55 sold a house for $5 million, but they were paying taxes on a lower assessed value based on their original purchase price, they could buy a new house for $2 million and still pay taxes at their original, lower tax assessment.” No doubt, a truly significant improvement to a tax hike reflecting current or “fair market” property reassessment.
Tax Assessments and Property Tax Breaks in California
Property taxes are typically based on assessed value rather than current fair market value. In most states, tax assessments are conducted every one to five years and are not changed when a property is sold or transferred as a gift or inheritance.
In California, to everyone’s relief, property tax relief measures have been voted into law to limit tax assessed value of property, as well as capping property tax rates, plus enabling beneficiaries inheriting property from parents to avoid high property tax reassessment – establishing a low property tax base right away, when inheriting a home from parents.
Much has been said about property tax relief on the critical side, by realtors and high net worth business people that benefit from tax increases… However, if you talk to working families, middle class Californians, and even upper middle class homeowners – you will hear nothing but praise for property tax relief laws such as Proposition 13, passed in 1978; and Proposition 58, passed in 1986 – enabling middle class families to avoid CA property reassessment… making tax breaks available to homeowners and beneficiaries such as property tax transfer; with the ability to transfer parents property taxes when inheriting property while keeping a low property tax base; with the right to keep parents property taxes basically forever… inheriting property taxes without issue from Dad or Mom whenever they pass.
Giving beneficiaries the ability to avoid CA property reassessment through parent to child transfer and a parent-to-child exclusion is a major asset to middle class residents in California; as well as being able to take advantage of Proposition 19, in conjunction with a loan to an irrevocable trust to buyout siblings’ share of inherited property – keeping a close eye on mistakes to avoid when transferring a property tax base. Now, the ability to avoid CA property reassessment and other property tax relief benefits are under serious threat.
All of this was planned, launched and protected by Howard Jarvis and his famous Taxpayers Association, as well as others who joined in the effort beginning in the mid 1970s, when property tax increases were basically out of control… often forcing elderly widows and others living on a fixed income, literally onto the street with their furniture piled up around them on the sidewalk!
Not the way anyone with a conscience would want elderly Californians to end up, in the Autumn of their life – simply to benefit a few real estate firms who will make more money from increased sales (with more homes for sale due to increased inability to pay rising taxes), with the CA Legislature piling up tax revenue higher and higher as property tax revenue increases. Perhaps helpful to a few in the short term… but with dire consequences in the long term for the entire state.
Experts Weigh In on CA Property Tax Relief
“In 1978, California voters approved Prop. 13, a constitutional amendment known as ‘The People’s Initiative to Limit Property Taxation’ that was meant to protect older residents who were unable to keep up with large property tax increases”, Gaye Chun tells us; and adds, “Several propositions since then have tinkered with property taxes.”
“Homeowners who plan to transfer their residence to their children now or as part of their inheritance should seek professional advice, so they understand the impact of the new property tax rules”, asserts Bruce Macdonald, the well known attorney in El Segundo.
“Current changes in property tax rules could be significant for some families, because it’s not that unusual in California to have a house that was assessed at $150,000 when the parents bought it, to be worth $5 million 40 years later,” Mr. Macdonald, Esq. explains; adding, “When the kids could inherit their parents’ house at the assessed value of $150,000, the property taxes would be approximately $1,500. Now, if the house is assessed at $5 million, that would incur a significantly higher tax bill!”
Experts in California tell us that this points to all the more reason for repealing Proposition 19… as well as adding more concrete protections to keep Proposition 13 safe from anti-property-tax-relief realtors and the politicians that are firmly in their pocket.
As of Feb. 2021, so-called “tax basis portability” has been available to beneficiaries and homeowners, under the new Proposition 58 quasi-replacement, CA Proposition 19. Tax basis portability is a way to reduce the assessed value of your home. As a result, you have the generally significant benefit of lower property tax liability.
With “tax basis portability”, you can transfer the old assessed value of your previous home, to your next home. For instance, if you own a house with an assessed value of, say, $400,000. You sell it for $600,000, and purchase a house for, let’s say, $550,000. So rather than a new reassessed value of $550,000, you can apply to reverse the value of the property back to the previous assessed value of $400,000. Therefore, the lower value can shave roughly $1,800 off your property taxes every year. OK, it’s not a million dollars, but it adds up…
As long as you can verify that you are –
age 55 or older;
or severely disabled;
or own a home that has been significantly damaged by forest-fire or wildfire, or a natural disaster, such as a flood.or severely disabled;
plus, are inheriting a home that was a principle residence; and are moving into the property only as a principle residence.
“Portability” is language used to define estate tax law that enables a surviving spouse to use an estate tax exemption left by a deceased spouse to protect valuable assets during the surviving spouse’s life, or at the surviving spouse’s death.
Potential Issues with a Replacement Property
A “replacement property” can be purchased prior to the sale of home you are currently living in. Of course there may be some problems property tax relief critics, realtors, politicians, and the Legislature doesn’t like to acknowledge – such as the size of an inherited home, your family may be way too large for it. Or the inherited home may be in an undesirable area.
If you have children in school, the school in the new school district you may find yourself in might be completely inferior to the previous school, upsetting your children. Or your commute to work may end up being an extra 4 hours on the freeway, getting to and from your new inherited home!
These issues can be exhausting and debilitating in the long run. Certainly something to consider. In a perfect world, these issues would not surface and become a big problem when you inherit a home from a parent. However, it’s generally not a perfect world.
Improvements to Propositions 60, Prop 90 & 110
Revisiting several of the new property tax relief options… One can safely say, despite components that are perhaps not so helpful – that Proposition 19 is, in some ways, less restrictive than the old Proposition 60, Prop 90, and Prop 110. There are no more county or sales price restrictions, and people can use the Proposition 19 property tax benefit more than once in a lifetime.
Proposition 19 Benefits
a) County restrictions are eliminated… The older rules limited the location of the properties in question. Proposition 60 restricted the tax basis portability within one county. Proposition 90 expanded that to a certain list of counties, so you could sell in one county and buy in another, but only if they were on that list.
b) Under Proposition 19… instead of limiting the counties of transfer, you can use this benefit anywhere in California.
c) No more sales price restrictions… Under Propositions 60 and 90, only transfers of “equal or lesser value” were eligible for tax basis portability.
d) A transfer of low tax basis… is now enabled by Proposition 19, regardless of value. However, certain adjustments to the tax basis are required if the purchase price of the replacement property is higher than the sale price of the previous home.
New Proposition 19 Restrictions for Inherited Properties
On the other hand, under Proposition 19, beneficiaries could see a substantial increase in their property taxes for inherited property. While property tax relief in California had no exclusion or exemption limitations under Proposition 58, current property tax law exclusions under Proposition 19 apply strictly to the first $1,000,000 of inherited property value.
For instance, should your inherited property (i.e., primary residence) be assessed with a market value of $2,000,000 upon transfer to you as the official beneficiary, newly assessed value will be $1,000,000. In other words, $2,000,000 minus $1,000,000 (i.e., the first $1,000,000 of property value) – will equal a $1,000,000 limited exclusion.
Although you are most likely aware of other changes and limitations imposed on California property tax relief, it bears repeating. As a beneficiary inheriting CA property taxes from a dad or mom, you now have to reside in a home only as a primary residence, if you are to take advantage of the Proposition 19 tax break, providing an exclusion from property tax reassessment at current market rates. You can no longer receive an exclusion from reassessment for an investment property.
Some say the underside to this reveals a change that mainly benefits the realtor community in California – using the Bridges family as their one and only singular example of inheriting CA property taxes from a wealthy parent, in this case a luxury beach- front property being used as a lucrative investment property; saving a great deal in taxes – while renting out to wealthy vacationers for $15,000 per month.
For whatever reason, critics of property tax relief have as yet produced very few specific examples of this type of inherited property used for “rental revenue” purposes, as opposed to “primary residential” purposes. Incredibly, the property tax law removing Prop 13 and Prop 58 property tax breaks from investment properties is apparently based on this one oft-told, tired tale of the Bridges family!
As you probably also know – as an inheritor, you have only 12-months in order to establish your inherited property as a principal or primary residence, to avoid property tax reassessment. However, if your inherited property value is more than $1,000,000 over the original tax basis, you are most likely still facing property tax reassessment – and this can hit the pocketbook hard. This may encourage you to sell out, if that’s the case.
Help From Property Tax Specialists
If you don’t want to sell your inherited home, you may be inclined to enlist the help of a property tax consultants for example (great proponents of property tax breaks, and supporters of Propositions 13 and 58); or a trust lender like Commercial Loan Corp, with a loan to an irrevocable trust – and buyout your siblings, if you have siblings, who prefer to sell their property shares from the same inherited property you have received from your parents.
You can establish a permanent, low Proposition 13 tax base this way, and take over 100% of the inherited property equity, with the trust loan paying off anything owed on the inherited home. Plus, your siblings will end up with a good deal more cash from the trust loan than if they had sold out to an outside buyer.
Proposition 19 Changes to the CA Parent-Child Exclusion
Let’s say a parent owns a home that is his or her primary residence plus a rental property (such as an apartment building or commercial building) in California. The home has an assessed value of $500,000 and a fair market value of $3,000,000. The rental property also has an assessed value of $500,000 and a fair market value of $2,000,000. Even though these properties have different current market values, their property tax liability is similar because they have the same assessed value. The combined annual property tax of both properties with a property tax rate of 1.25% is $12,500.
Prior to Proposition 19: Let’s say the parent in this example wanted to transfer both properties to his son. There was no reassessment on the transfer of either the home or the rental property from father to son. The home before Proposition 19, under Proposition 58, could be transferred to the son irrespective of its’ value, since it was the father’s primary residence, and the assessed value of the rental property falls below the $1,000,000 threshold.
Therefore the combined annual property tax stays at $12,500. Moreover, there were no restrictions on the son’s usage of either property – therefore the son might have used both properties as investment properties if that is what he wished to do.
Outcomes Under Proposition 19: Let’s say new assessed value of a house is $2,000,000 since the current market value is larger than the assessed value by more than $1,000,000 (i.e., the new assessed value has a current market value of $3,000,000 minus $1,000,000). The new assessed value for the rental property is its fair market value of $2,000,000 because no exclusion or exemption from reassessment at current market rates applies to transfers of property from parent-to-child other than a primary residence.
Yet if it is indeed a principle residence that beneficiary or heirs are moving into, in keeping with the 12-month inherited property move-in deadline – all the bells and whistles really are still there to be taken advantage of – such as inheriting CA property taxes from parents, having the right to continue transferring property taxes while avoiding property tax reassessment, while being able to use a Proposition 19 loan to an irrevocable trust to keep a parents low property tax base as well as buying out siblings’ inherited property shares – formerly a Proposition 58 transfer of property between siblings…
By the same token, heirs or beneficiaries of inherited property can make full use of any property tax transfer as long as these new restrictive requirements are met… an inheritor can transfer parents property taxes and likewise keep parents property taxes thereafter upon inheriting CA property taxes from ones’ father or mother – and complete the process with a parent-to-child transfer and parent-child exclusion. Californians are still able to successfully avoid property tax reassessment by inheriting CA property taxes from parents, in the final analysis, keeping a low property tax base when inheriting a home. The key to property tax relief in all 58 counties in California.
The new combined annual property tax will be $50,000. In addition, the son has to use the inherited family house as his primary residence or that property is sure to be reassessed at the current market value of $3,000,000, which will increase the combined annual property tax for both properties to $62,500.
You see the difference? This accounts for the growing push-back on Proposition 19…despite all the positive elements that come with this property tax measure.
