In California, estate planning revolves heavily around avoiding reassessment and planning for a step up in basis to avoid capital gains for real estate transactions. Real estate holdings are often the centerpiece of a family’s wealth. Prop 13 protected those properties from reassessment, regardless of the quantity or value of real estate passed down through the generations, and regardless of how those properties were used. Transfers could occur during life or after death.
Beginning on February 16, 2021, this will no longer be the case. Prop. 19 abolishes this tax break on any property not being used as a primary residence or certain farms. This means, for example, that if you are passing down the family business and own the building that the building will be reassessed.
Clients who may inherit or intend to leave the next generation any property other than a residence that a child will also reside in (income-producing properties, commercial properties, vacation homes) should contact their advisors immediately to discuss how this new law may impact their children’s ability to keep the property and whether it makes sense to transfer ownership of the property now (before February 11, 2021, to allow time for the weekend and holiday) while the Prop 13 tax assessment can be preserved.
What Prop 19 Means for You and Your Clients
Financial Advisors: Real estate is often a substantial element of your client’s portfolio – one you are not managing or advising on. Please let your clients know that they must, as part of their end of year tax planning, address Prop. 19 with their estate planning attorney and perhaps discuss it with their parents and siblings immediately.
Insurance Professionals: Life insurance is a terrific shield against what can be punishing “death taxes”. If your client owns property that holds their family business, could a life insurance policy defray some of the pain this tax increase would cause? If one child is inheriting a home they will live in and the other an income or commercial property, can life insurance be used to make things “fair” and “even”?
Business Attorneys: If your clients own the brick and mortar for their family business, it is imperative that they speak to an advisor. Could the business weather reassessed property taxes when the founder passes away or should that real estate be transferred to the next generation now?
Real Estate Attorneys: While effecting the transfers is a simple matter for real estate attorneys, they should recognize that these transfers of wealth only make sense in the larger context of federal estate tax and gift laws. Every client should conduct a full analysis of the risks and benefits of transferring real estate to the next generation.
Other Considerations: As always, tax planning can feel like playing a game of whack-a-mole. You find a terrific solution that works under state law, and find that you have given yourself a big federal tax black eye. It is important to never DIY this type of planning. This law passed on November 3rd. The sharpest tax lawyers in California have yet to weigh in, and all eyes are towards Washington D.C. as changes to the federal estate tax are anticipated under the Biden administration as early as late January.
I am an estate planning attorney, not a tax attorney, and by no means an expert in taxable estates or California real estate taxes. Spotting issues for my clients and bringing on the right team of experts to help them create an estate plan that promotes their values and preserves family harmony is at the core of my business. I will be asking my clients if it is “fair” to leave a primary residence to one child and an income-producing property to the other, given this change in the law. How can we address other assets in the trust to create equity among siblings? How do we leave one child a family business, and an enormous continuing tax bill, and the other child the family home they intend to live in, without causing ill will between the children?