New California Inherited Property Tax Rules Prompt Backlash
Voter-approved tax increase is aimed at the wealthy
Lower-income families say they’re caught unexpectedly
By Laura Mahoney / May 5, 2021 04:45 AM ET / Bloomberg Law
California families surprised and angry that they lost a property tax break on inherited homes or businesses at the November 2020 ballot box are fighting to get it back.
The California Association of Realtors pitched the measure (Proposition 19) to voters as a way to close loopholes “exploited by East Coast investors, celebrities, and wealthy trust fund heirs to avoid paying their
fair share on vacation homes, beachfront rentals, and luxury estates.” The group provided most of the $57 million spent on the campaign, which succeeded in a 51.1%-48.9% vote.
Some of the central arguments used to convince voters to pass the initiative—that it would increase the housing supply and thus make housing more affordable—are now being used to try to reverse it with another ballot measure or legislation. Critics are saying the new law will drive up home prices and rents along with taxes—exacerbating income inequality—whether families keep inherited properties, rent them out, or sell them.
“If we want to make housing more affordable, this is completely counterintuitive,” said Kerry Riordan Sykes,
an estate and trust attorney in San Francisco. “This is the meanest proposition I have ever seen.”
Firefighters to See Funds
The Realtors are defending the law as the will of the voters.
“Prop. 19 was supported by a statewide bipartisan coalition and we’re working to ensure the tax benefits for homeowners are working as intended,” Sanjay Wagle, Realtors senior vice president, said in an email.
The coalition includes the California Professional Firefighters, who will get new funding at their state and local agencies from the new law’s tax gains, and the California Democratic Party, which spent more than $1 million on campaign mailers and voter data to back the measure.
Sykes said many of her clients are first-generation American families with one major asset: the family home.
In a city with a median home price of $1.65 million, many of them are comfortable but not wealthy, she said.
If they sell homes they inherit they’ll face capital gains taxes on large profits, and if the Biden administration succeeds in eliminating stepped-up basis rules that reset the value of inherited property to the time of
inheritance, the tax bills will be even higher, Sykes said.
At the foundation of all California property tax discussions, including this one, is a 1978 state law that caps tax at 1% of the purchase price with annual increases of no more than 2% for inflation. Voters also approved
measures in 1986 and 1996 allowing parents and grandparents to pass those capped values for one residence and up to $1 million in assessed value of other properties to their heirs.
Proposition 19 repealed the two inheritance laws. Instead, all inherited properties will be reassessed at market value except one primary residence, and only if an heir lives in it. If an heir lives in a home with a market value less than or equal to the current assessed value plus $1 million it won’t be reassessed. If it is over that threshold, county assessors will use a new formula to increase the assessed value.
The new rules are expected to generate hundreds of millions of dollars per year, and more than make up for lost revenue from another part of Proposition 19 that expands similar property tax breaks for seniors, the
disabled, and disaster victims, allowing them to transfer their capped value to a new home anywhere in the state up to three times. The revenue is earmarked for local and state firefighting efforts, giving the firefighters an interest in keeping the law as it is.
Values Have Skyrocketed
The revenue will come from families that have owned homes for decades in high-cost areas along the coasts, in cities, and in Silicon Valley, where values have skyrocketed. The statewide median price of existing single family homes reached a record high of $758,990 in March 2021, according to the Department of Finance. It is unclear how many families will fall under the new rules, although the nonpartisan Legislative
Analyst’s Office said in a 2017 report that 650,000 properties, or about 5% of all properties in the state, had passed between
parents and their children in the previous decade.
In Santa Clara County, the epicenter of Silicon Valley, the average sales price for a home rose to $1.69 million in 2020 from $665,222 in 2003. At the same time, the average, capped, assessed value went to
$812,463 in 2019 from $352,271, according to the most recent data from the Santa Clara County Assessor’s Office. Meanwhile, 35% of the 428,543 single-family homes and condominiums in Santa Clara last changed hands before 1998, with 11% of those homes last sold before the 1978 law capping the tax. Children inheriting them will be facing a choice: move in and keep property tax low, rent to tenants and face reassessment at market value, or sell.
Santa Clara County Assessor Larry Stone said the measure was poorly written and will have some unintended consequences.
“The whole thing was designed by Realtors to generate more transactions and commissions,” he said.
Nevertheless, Stone said, he supports the policy behind it. The home he bought in 1975 for $85,000 is now assessed at $276,000 but it is likely worth $3 million. He questions why he should be able to pass the low
assessed value to his heirs in perpetuity.
“No one is ever going to convince me that’s fair,” he said.
Craig Duncan is one of four siblings who will inherit their childhood San Diego home purchased in 1975 and
four rental homes from their 89-year-old mother, a retired schoolteacher. He estimates the family’s property tax bill will increase by 311%.
Like many families, the Duncans scrambled after the measure passed to figure out how it would impact them before the new rules took effect Feb. 16. County assessors reported a deluge of people requesting help and recording property transfers to beat the deadline. With their mother in an assisted living facility and suffering from dementia, and the constraints of the Covid-19 pandemic, the siblings were unable to change her estate plans in time to avoid higher tax bills, Duncan said.
His mother began investing in real estate to supplement her income after her divorce in the 1980s, and revenue from the rental properties funds her retirement and now her assisted living expenses.
Craig Duncan estimates the total tax bill for the five properties will increase from $11,298 to $46,500 a year after they inherit them. He said it is reasonable to pay more, but not that much more. The siblings are considering renting their mother’s home or raising rents at the other four homes, which are in lower-income areas, to pay the higher bill.
“If my mother passes away, we’re getting zapped,” Duncan said.
Family farmers face another set of problems, according to the California Farm Bureau Federation. Properties with housing rented to farm workers and acreage that is fallowed or leased to other farmers would be
reassessed, said Robert Spiegel, a lobbyist for the bureau. Families that place their farms in business entities like limited liability companies may need to restructure, and the $1 million exclusion won’t be much help if
farms are made up of multiple parcels.
“I say to my clients, tongue in cheek, the next time you see a Realtor, kick them in the shins,” said Ted Stephens, a timber farmer in Mendocino County who is also a financial adviser to farmers.
State Board of Equalization Member Malia Cohen (D), who represents San Francisco and coastal Northern California counties, is saying she wants the inherited property rules reinstated because the changes upend
the notion of building generational wealth with a primary residence, harming middle-income families and communities of color.
“We are not talking about $25 million palaces in Malibu,” Cohen said. “We are talking about middle class homes in Bayview Hunters Point in San Francisco, or Baldwin Hills in Los Angeles, or Encanto in San Diego,
and other communities throughout California, that were purchased for less than $100,000 decades ago, and now have a market value well over $1 million.”
Another Ballot Measure?
It would take passage of another ballot measure, in 2022 at the earliest, to reinstate the tax break. The Howard Jarvis Taxpayers Association—the group that won the landmark 1978 property tax cap—is
considering that option and has launched a website called Reinstate 58, in reference to the ballot measure that created the break in 1986.
Association President Jon Coupal compared the new law to an estate tax, which California voters abolished at the same time they approved the inherited property tax break.
“It’s the flip side of the same coin,” he said.
Coupal and other critics are also pinning their hopes on a bill (S.B. 668) by Sen. Patricia Bates (R) to delay the new rules for inherited property until 2023 because they took effect with little warning at the height of the
pandemic, when government and law offices were closed and people had limited access to help.
The Realtors and firefighters, in a joint letter to lawmakers, said they oppose Bates’ bill on constitutional grounds. Because the Feb. 16 effective date was included in the constitutional amendment, another ballot measure is necessary to change that date, they said.
A technical bill to clear up confusing provisions of Proposition 19 (S.B. 539) is also moving through the Legislature. The California Assessors Association helped draft the technical bill and is working with the
equalization board on regulations to help smooth many wrinkles that have arisen since the law passed.
Duncan said he and his siblings no longer live in San Diego and haven’t decided what to do. It seems the new law is designed to increases taxes so much that families will be forced to sell their homes, he said.
“It’s a shit sandwich with some M&Ms in it,” Duncan said.
To contact the reporter on this story: Laura Mahoney in Sacramento, Calif. at lmahoney@bloomberglaw.com
To contact the editors responsible for this story: Jeff Harrington at jharrington@bloombergindustry.com; John
Dunbar at jdunbar@bloomberglaw.com
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