08 Jan Real Estate Measures
“In 1978, California’s Constitution was amended pursuant to the approval of Proposition 13…”
On November 3, 2020, Americans not only voted for the next President of the United States of America, but also for local government officials and ballot measures. Specifically, Californians voted for Proposition 19, which was placed on the ballot by the Legislature. According to the Secretary of State’s official Election Results of the California General Election, Proposition 19 passed with 51.1 percent of the vote.1 The margin between Ayes and Nays is somewhere around 360,000 votes. Considering the population of the State of California is approximately 39.7 million residents and includes over 22 million registered voters, this difference is marginally thin. Nonetheless, Proposition 19 was certified on December 11, 2020.
Modern History of California’s Property Tax Assessment
Before we take a scalpel to Proposition 19’s language, we must first introduce to you the cleaver and the butcher block. So, grab your apron “’cuz things are gonna get messy.”
In 1978, California’s Constitution was amended pursuant to the approval of Proposition 13, which was put on the ballot by petition signatures. Proposition 13, also known as the “Holy Grail of the tax revolt” was developed by Howard Jarvis and was designed to:
- Require properties be taxed at no more than one percent of their full cash value shown on the 1975-1976 assessment rolls and limit annual increases of assessed (taxable) value to the inflation rate or two percent, whichever was less;
- Permit properties to be reassessed at one percent of their sale price and reset the limit on annual increases of assessed value upon the transfer of properties;
- Prohibit the State Legislature from enacting new taxes on the value or sale of properties;
- Require a two-thirds vote of the State Legislature to increase non-property taxes;
- Require local governments to refer special taxes to the ballot and require a two-thirds vote of electors; and
- Make the State government responsible for distributing property tax revenue among local governments.2
In 1986, further amendments were made to the State’s Constitution that broadened the circumstances in which California reassessed property taxes through Proposition 58, which was legislatively referred to the ballot. Proposition 58 was an amendment to Proposition 13 and applied to real estate transfers between spouses, but more importantly between parents and their children.
Specifically, it prohibited property tax reassessment if a family’s primary residence, regardless of its value, was transferred between parents and their children, then limited reassessment on other real property valued at over $1 million dollars.3
In the same year, 1986, voters also approved Proposition 60, which amended Proposition 13 to allow homeowners over the age of 55 to transfer the taxable value of their present home to a replacement home, if the replacement home was of equal or lesser value, located in the same county, and purchased within two years of selling the original home.4
Proposition 13 was amended again in 1988, with the passing of Proposition 90, which allowed qualified homeowners age 55 or older to purchase a replacement home in a new county, but only if the new county agreed to partici pate in the reassessment program, pursuant to Proposition 60.5
November 2018’s primary election ballot included Proposition 5, which proposed another amendment to Proposition 13. The amendment would have permitted homebuyers who are either age 55 years or older, or severely disabled to transfer the taxable value of their present home to a replacement home, no matter the value of the replacement home, regardless of the county it was in, nor did it limit the number of the buyer’s moves.
The ballot measure had one committee registered in support of the measure. That committee’s campaign raised $13.22 million; 77 percent of the amount raised by that campaign was from the California Association of REALTORS® Issues Mobilization PAC, and the other 23 percent was from the National Association of REALTORS®. The major opponent to the measure was the California Teachers Association and Assemblyman David Chiu (author of AB 1482—a statewide rent control measure and AB 3088—the legislature’s response of firefighting associations, Black and Hispanic Chambers of Commerce, and senior and disability advocates. Opposition included the Howard Jarvis Taxpayer Association, Family Business Association, the League of Women Voters, and a number of Editorial Boards.7
What Is the Difference Between Proposition 5 and Proposition 19?
What changed? Nothing, really… well, except for the language.
You see, back on December 3, 2018, when it was apparent that Proposition 5 was going to fail, the Legislature met and quickly made one final decision before the 2019-2020 Regular Session would break for the winter. With two-thirds of each house, a constitutional amendment was approved, and they titled it the Home Protection of Seniors, Severely Disabled, Families, and Victims of Wildfire or Natural Disasters. This constitutional amendment would later become known as Proposition 19.8
As the State of California continues to be governed by a progressive legislative body, it has been seeking opportunities to take revenue from the State’s taxpayers through a veil of carefully crafted language turned law by preying on the emotions of the electorate.
Before voters went to the polls on November 3, 2020, they likely read about Proposition 19 in the Secretary of State’s Official Voter Information Guide. When reading the “argument in favor of Proposition 19,” four talking points are noted and included:
1. Limits property taxes for seniors, wildfire victims, and disabled homeowners;
2. Closes unfair tax loopholes used by East Coast investors, celebrities, and wealthy trust fund heirs on vacation homes and rentals;
3. Increased fire protection, emergency response and school funding; and
4. Democrats and Republicans support Proposition 19.9
The words used to craft the supporting arguments are very persuasive; so, even if a voter read only the language IN ALL CAPS at the beginning of each talking point, the voter is already enticed to vote “Yes”. Why, you may ask? First, because California has been devastated by wildfires in recent years and growing concern continues to garnish international headlines; and second, because the average taxpayer does not prefer to hear about wealthy investors buying up homes in California, they are candy from the five and dime. This causes a fear that Californian’s housing crisis is the fault of investors snatching up houses. Houses the average California family can barely afford.
What Does Proposition 19 Actually Do?
Seniors, Wildfire Victims, and Disabled Homeowners
Proposition amends provisions include additional qualified homeowners who may take advantage of special circumstances prohibiting a property tax reassessment. Homeowners who qualify are those who are the age of 55 or older, severely disabled, or a victim of a wildfire or natural disaster.
Proposition 19 expands Proposition 60 transfers to three transfers per lifetime in any county and can be utilized when the purchase price of the replacement property is greater than the purchase price of the original property. In the case of property purchased with a higher value than the original property, the new taxable value would be equal to that of the taxable value of the original property plus the difference in value between the sales price of the original property and the sales price of the replacement property. The new law expands the persons these transfers are available to by including victims of wildfire or other natural disasters.
Although the language reads well and seemingly offers more freedoms for the elderly, the disabled, and victims of natural disasters when seeking replacement homes, two questions that remain come to mind. One, for the elderly who do not move into an assisted living facility and the severely disabled who are on a fixed income, how do they afford to move multiple times and how would this affect the real estate market in terms of houses for sale? Two, when a homeowner becomes a victim to natural disaster and has lost every tangible item collected over decades of time (let’s not even discuss the insurance issues), how does that homebuyer afford to make multiple moves when they have to rebuild… start all over?
Real Property Inheritance Transfers According to the California Association of REALTORS® the median sales price of a single-family home in the State as of October 2020 was $711,300. It is argued that many homeowners that utilize the provisions of Proposition 19 should be slim next to none, unless they decide to move due to reasons associated with health or family reasons.
Children that inherit their parents’ prop erty will likely move into their parents’ property due to loca tional needs, family circum stances, job performance and many other legitimate decisional factors and Proposition 19 should accelerate sale of property. Sale of properties in this situation will benefit many, including government. Renters at many levels may be adversely affected. Renters may be witness to a shrinking housing supply and increases in rent.
Current law permits parents the ability to transfer the principal residence of unlimited value plus up to $1 million of adjusted base year value of any nonprincipal residence properties to their children without triggering reassessment. Proposition 19 severely limits these non-reassessment transfers.
Effective February 16, 2021, the parent to child reassessment exclusion will be limited to the principal residence of the parent and will require that the child utilize the property as their own principal residence. Additionally, even if the child utilizes the residence as their own, there is a cap of $1 million on the exclusion. Is it realistic to assume the child will retain ownership of the property? Many would suggest the child will sell the property.
Second, if one or more of the children move into the primary residence as their primary residence following the parent’s death, little will change. The probability of two of more children moving into the parent’s residence will be slim! The probability of one child moving into their parent’s residence if the child already owns and occupies their residence will be slim.
If the children sell the family home, rental properties or commercial properties after the demise of the parents, additional financial planning is not required. Section 101 of the Internal Revenue Code provides that properties that a person owns receives a stepped up basis following a (parent’s) demise thus washing away all capital gains upon death of the parent. On the other hand, if the property is given to the children during the parent’s lifetime, the adjusted basis of the parent carries over to them and essentially inherits the parent capital gains. The ability to receive a step up in basis on properties owned by a parent can save tens of thousands of dollars in capital gains taxes and is often far better than potentially saving thou sands of dollars in property taxes by gifting property at this time.
If the parent owns a vacation home that children will most likely retain when the parent dies, concern with the potential capital gains taxes should not be of concern. It may be worth taking into considering gifting the property to the children before February 21, 2021, either as an outright gift or in an irrevocable trust.
If you have rental properties and/or investment properties in excess of $1 million, parents should consider placing those assets into a limited liability entity and gifting the fractional interests to the children or grandchildren to protect the current assessed value from reassessment upon the parent’s death.
If one is planning on transferring non-principal residence property (rentals) to one’s children or are currently utilizing a qualified personal residence trust (QPRT) with a vesting date after February 16, 2021, there are financial planning options that must be immediately explored. The window to make pre-Proposition 19 transfers is limited and prompt attention should be of great importance.
Heavy-handed arguments were made in support of Proposition 19 and they were in reference to creating additional resources for the State’s fire protection and management. These additional resources would come from the reassessment of property taxes pertaining to homes being passed from parents to their children. The Legislative Analyst’s Office (LAO)10, however, analyzed the measure and noted concerning information regarding the revenue earned versus the cost of making such a drastic constitutional amendment.
The LAO projects that approximately $65 billion is raised each year for local governments through property taxes. The LAO projects that the constitutional amendment will increase the annual revenue, which means that local governments could gain tens of millions of dollars of property tax revenue annually. Yet, in the same analysis, the LAO notes that it is likely that counties would probably need to hire new staff and make computer upgrades to carry out the measure, which could increase county costs by tens of millions of dollars.11
Admittedly, the LAO also projects that if revenue increases over the years, the financial gains to local governments and schools could grow to a few hundred million dollars annually. The question, however, is how fast the growth rate will increase. Legislators and government officials, alike, have acknowledged the housing crisis; when the average homebuyer is forced to rent due to the inability to afford the purchase price, how many homes will actually sell?
Pursuant to the constitutional amendment, no later than September 15, 2022, and each subsequent September thereafter, revenue received from the additional property taxes will be transferred from the general fund to the California Fire Response Fund equal to 75 percent of the amount received and calculated by the State’s Director of Finance.
Fifteen percent of the amount received shall be transferred to the County Revenue Protection Fund and shall be sued to reimburse eligible local agencies with a negative gain.12 75 + 15 = 90; so, if the math is correct, then only 10 percent of the additional amount received from property taxes as a result of Proposition 13 would be allocated for schools, State wide!
According to basic math, if there was an additional state revenue of $10 million received and calculated by the Director of Finance, then 10 percent of $10 million is $1 million. There are 58 California counties; $1 million divided by 58 counties = $17,241.38. Each county would receive $17,241.38 for their schools. Now let’s imagine for a moment how many schools there are in Los Angeles County.
How would $17,241.38 be allocated to each school?
Rental Housing Market
Financial planning, implementation, confusion in language and many other aspects are pale in comparison to the impact on rental housing, notably affordable rental housing.
One of the ever-present issues that will be tested will be if residential rents will rise, single-family rentals will be sold to owner-occupants or revenues will shrink as a result of Proposition 19. It may be appropriate to closely watch the practical implementation of the ballot measure. There is a compelling argument that tens of thousands of single-family properties will be sold as a result of Proposition 19.
With the passing of Proposition 13, over 40 years ago, came the prohibition on the State Legislature from enacting new taxes on the value or sale of properties.
While it is known that the Legislature did not technically enact a new tax on the value or sale of properties, it did approve language and refer that language to the ballot for voters to make the decision. The problem is the inference that the Legislature used experienced logodaedalus to use the power of persuasion during a national pandemic deliberately to cause confusion among California voters in hopes of success.
As California continues its progressive march forward, its citizens become guinea pigs for the “Art of Words.”.
Just how long will it be before we are all mere puppets on a string?
10 The California Legislature’s Nonpartisan Fiscal and Policy Advisor
Ron may be reached at [email protected]