If you own rental property in the San Francisco Bay Area, where real estate values are currently sky-high to say the least, then Prop 19, current real estate prices, and selling are of special interest to you: to give you an idea of where prices stand as of this post, the median home price in Marin County north of San Francisco just hit $1.49 million. Even though prices have only risen 6% in Marin according to a local trusted realtor, that is still 6% on top of already sky-high prices.
For example, a typical, not-very-special, two-bedroom condo has gone from $735,000 to $779,100 since last year, which was a pretty hot year for this location (15 mins to get across the Golden Gate Bridge to San Francisco). The equity has more than doubled in the ten years I have held the condo. Time to sell?
Sweet But Not All Roses
Making big gains can smell pretty sweet, but it’s not all roses when it comes time to selling appreciated California real estate, such as this condo, if you are thinking of keeping it all in the family by selling to family. At the time of this post (March 2022) selling to family is essentially like selling to anyone in terms of tax basis benefits. In other words, Prop 19 eliminated the exclusion from property tax reassessment for transfers of property from grandparent to grandchild or parent to child.
Intergenerational Wealth, Especially Immigrant Families Affected
Prop 19 greatly impacts the intergenerational wealth planning and strategy for small CA-based rental real estate business especially, who may not have the powerful legal and financial advice needed to navigate this new proposition and keep their families in the real estate game in California. According to a 2018 Report, California had the highest number of equity-rich homeowners in the U.S. (43.6%). Equity-rich homes are defined as homes in which the home value is 50% or more than total loan amount.
Also, California is unusual in that it has a large percentage of immigrant families who have built their wealth in real estate and want to pass it on to family (something like around 1/3 of CA residents are foreign-born.)
Prop 19 Is a Nightmare For Mom-and-Pop Landlords
Last year, on February 16 2021, California Proposition 19, the Home Protection for Seniors, Severely Disabled, Families and Victims of Wildfire or Natural Disasters Act came into affect. It has some very beneficial effects for certain families (homeowners who are over 55 years of age, disabled, or victims of a wildfire or natural disaster) who can transfer the assessed value of their primary residence to a newly purchased or newly constructed replacement primary residence–for up to three times. This is pretty sweet. No, REALLY sweet. California has suffered from more FEMA-declared disasters than any other state (average of 16 every year, for years 2014-2018). Is it time to sell CA-based real estate?
However, for more fortunate families who want to transfer wealth in the Prop 19 era, it’s a nightmare because much of the careful tax planning for passing on real estate is gone. Prop 19 replaces this tax-saving program: Proposition 58(1986) and Proposition 193(1996), because it limits parent-to-child transfer and grandparent-to-grandchild transfer exclusions.
Are There Prop 19 Reassessment Loopholes?
The most obvious and clear way to deal with Prop 19 is for parents to follow Prop 19: transfer their primary residence (“family home”) or family farm to their children and at least one of the children then lives in the property as his or her family home going forward. Note that the family home qualifies for the exclusion only so long as the eligible child uses it as their primary residence.
According to Jacqueline Yu Law, a Los Angeles-base legal firm, “there is no reassessment for a transfer of 50% or less of ownership in a real estate holding. For this reason, parents can transfer real property to their children without reassessment if the real property is owned by an LLC, partnership, or corporation.”
Therefore, it may also be possible to transfer CA-based real estate wealth to the next generation in a tax-efficient way directly using one or the other of these LLC rules: Change in Control or Change in Ownership. These rules are governed by the California Revenue & Taxation Code (R&TC). Using the LLC as an example works because an LLC is generally easier and cheaper to form than other corporate entities.
- LLC Change in Control Rules: reassessment is triggered when a party gets more than a 50% ownership interest in the LLC
- LLC change in Ownership Rules: more than 50% cumulatively of original co-owners’ interest in the legal entity is transferred.
If decide to hold real estate in a California LLC, here is the LegalZoom article on how to change ownership.
For Previously Acquired Real Estate
If you acquired a rental property previously and it has greatly appreciated, you may be able to postpone re-assessment if you transfer the property to an LLC in a transaction excluded from reassessment under the Change in Ownership Rules. Exclusions are either automatic or require a claim to be filed with the State of California.
For Recently Acquired Real Estate
When real property owned by an LLC changes hands it is subject to the Change in Control Rules or the Change in Ownership Rules. Put very simply, parents or grandparents can form an LLC, give fractional interest to their children, and transfer the recently acquired rental property to the LLC.
The parents’ interest in the rental property and the LLC aren’t the same, so the rental property does trigger a property reassessment, but as long as the recently acquired rental property hasn’t appreciated much yet, the Change in Control Rules apply and the property tax increase won’t be a big burden.
As always, consult your tax advisor and/or legal professional.
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Disclaimer: All the information provided above and on this site is for informational purposes only and should not be considered as professional investment, legal, or tax advice. You should conduct your own research or consult with a professional financial advisor when investing.