Homeownership in our community has proven to be one of the best investments a person could make. A home purchased 25 or 30 years ago for $100,000 may now be worth $3 million, $4 million, or more. Because of Proposition 13, property taxes are also remarkably low.
Here are two vitally important things to think about with regard to homeownership.
Reverse mortgage
A reverse mortgage enables you to tap into the equity in your home in the form of a lump-sum loan or monthly distributions. It is enticing because there is no payback until you pass away – but the fine print is remarkably important.
It is not the case that there is no downside with a reverse mortgage. While it can be a way to pay for costly home-care services that might otherwise be unavailable, it can shatter dreams.
A local condominium owner obtained a reverse mortgage five or six years ago. She took distributions to help pay for renovations and home-care services and to help out a daughter. While the condo is worth $1 million, she has no other assets.
The problem is that she had to enter a skilled nursing facility. An underappreciated fact is that the reverse mortgage loan becomes due if an individual moves out of her residence permanently. A year’s absence presumptively establishes the need to pay off the loan. The condominium owner’s loan is now due.
She is forced to sell the condominium. Because her capital gain is so large, more than $110,000 must be paid in the form of capital gains taxes. The $125,000 reverse mortgage loan will be paid off. She will then have cash in her bank account.
Because she now has more than $2,000 in liquid assets, she will lose eligibility for Medi-Cal, the program that was paying 90% of the cost of her nursing-home care. She qualified because her home was “exempt” and she had no other assets. She now has assets well in excess of the $2,000 limit. She will now be paying almost $12,000 per month for the cost of nursing home care. The value of her estate shrinks monthly. Given her life expectancy, approximately $350,000 will remain in her estate at the time of her passing.
What might she have done differently? Both of her children said that had they known of her needs, they could have loaned her money, avoiding the need for a reverse mortgage. Given the “stepped-up basis” at her passing, her condominium would then have been sold without capital gains tax exposure, Medi-Cal eligibility would be undisturbed and the net savings for this family would exceed $600,000.
Reverse mortgages can be a good thing in the right circumstances. In the wrong circumstances, they are a problem.
Proposition 19
Proposition 19 will not be repealed. The initiative to obtain signatures to place the repeal of Proposition 19 on the November ballot was unsuccessful, so it is therefore with us for years to come.
The reality of Proposition 19 has probably not sunk in: Upon your passing, your residence and other real property will experience a dramatic property-tax increase if your kids want to keep the property in the family.
A local family owns an average home, now valued at approximately $4 million. They have a vacation home valued at $1.2 million. Their two children, both in the Northwest, want to retain both properties, and their parents have the same dream.
Because of Proposition 19, property taxes on their residence will increase from $8,000 per year to approximately $45,000 per year. Property taxes on the vacation home will increase from $4,000 per year to approximately $15,000 per year. These increases will make retention of these properties untenable.
Before Proposition 19, both properties would have been passed along to their children without property-tax increases.
Most of us want to keep our homes and other real property holdings in our families. Fortunately, there are steps we can take to preserve the current level of property taxes for the next generation. It is not uncomplicated, but it can be done.
Avoiding the devastating impact of Proposition 19 could be the most important estate and tax planning step you will take in your lifetime.
Questions about the optimal approach to avoid these catastrophic property-tax increases can be raised with us or your estate planning attorney.
Property ownership is a blessing that has its complications. You need to understand those complications and how to address them.
Michael Gilfix, Esq., is a partner at Gilfix & La Poll Associates in Palo Alto. For more information, call (650) 493-8070 or email MG@Gilfix.com.