Every third week of the month, we write on a hot topic my clients have asked about and this week is how to transfer wealth when it comes to Proposition 19.
If you've been enjoying your home in the beautiful San Francisco Bay Area for the last 20 years or more, it's time to have a heart-to-heart about California (CA) Proposition 19 when it comes to transferring wealth and how it affects you and/or heirs' future property taxes. Let's get into the nitty-gritty of who should keep their homes, when it might be a good time to sell, and how to make the most of your hard-earned investment.
Who Should Keep Their Homes?
First things first, if your home is your sanctuary and you plan to live out your days there, Proposition 19 offers two protections for you.
If you stay in your home, you’ll keep your current property tax base, even if your home’s value has gone through the roof. That means no sudden jumps in your property taxes.
If you're over 55, severely disabled, or a victim of a natural disaster, you can transfer your low property tax base to a new home up to three times. This means you can downsize or move closer to family without facing a big tax hike.
However, how does this impact your heirs?
For your children to keep that low property tax basis after you pass, they need to make your home their primary residence. That means they need to live there, not just rent it out or use it as a vacation spot.
And even if your kids move in, there's a cap on how much of the home’s value can be excluded from reassessment. If the difference between the home's market value and the old tax value is more than $1 million, the property will be partially reassessed. In the SF Bay Area, where property values can be sky-high, this might affect many of you.
How To Calculate The New Tax Basis?
New Basis = Fair Market Value – (Previous Assessed Value + $1 Million) + Previous Assessed Value.
Let's look at an example. Imagine you bought home for $200K over 20 years ago. Now, the assessed taxable value is $400K because Proposition 13 helped slow the assessed value to 2% per year. Now, the fair market value of your home is $2 Million.
How much in property taxes would the children pay after you pass?
Option 1 - Heirs convert it into a rental property
The basis here would be the $2 Million fair market value re-assessed value.
Option 2 - Heirs move back in to make their primary
The new basis here would be the $2 Million fair market value - $400K + $1 Million + $400K, so $1 Million in new tax basis. Although its still much higher than $400K before Proposition 19, it's still lower than paying property taxes on the full $2 Million.
Option 3 - Sell the property + avoid capital gains tax
With the Step Up In Basis, your heirs will not have to pay any capital gains tax as long as they sell the home shortly after your passing with no improvements. If they improve the property, their gain will be the value from the time they inherited to when they sold.
In practice, Proposition 19 makes it less beneficial for inheritors to keep their family properties, incentivizing more homeowners to sell in order to realize the gains and avoid capital gains taxes. This also enables more housing inventory to change hands and fulfill more buyers' needs.
Maximizing Your Return on Investment
To get the most out of your investment, here’s a straightforward plan:
1. Assess Market Timing:
The Bay Area real estate market can be hot. Selling when demand is high can net you a significant return.
2. Consider Downsizing:
If you’re looking to stay in California, downsizing to a more manageable property and transferring your low tax base can free up cash while keeping your tax burden low.
3. Explore Investments:
Reinvesting the proceeds from a sale can offer you a steady income stream. This brings us to an intriguing option: a Deferred Sales Trust (DST).
Transferring Wealth - CA Proposition 19 vs. Deferred Sales Trust
Proposition 19 can save you on property taxes if you stay put or transfer your tax base within certain limits. But what if selling is on your mind, and you want to live comfortably off the proceeds?
Enter the Deferred Sales Trust. Here’s how it stacks up:
Tax Deferral:
With a DST, you can sell your high-value home, defer capital gains taxes, and reinvest the proceeds in various investments. This keeps more of your money working for you.
Income Stream:
A DST can provide a steady income, allowing you to live off the returns. This can be particularly beneficial if you want to travel, pay for medical expenses, or just enjoy a more flexible lifestyle.
Estate Planning:
A DST can be a smart move for estate planning, helping your heirs avoid hefty tax bills and making the transition smoother when the time comes.
In conclusion, dear friends, whether you keep your home or decide to sell, it’s all about making informed choices that best suit your lifestyle and financial goals. Consider the benefits of Proposition 19 if you’re staying put, and explore a Deferred Sales Trust if selling and enjoying a steady income sounds appealing.
If you have any questions about this topic or others, feel free to reach out to me directly at 650.451.8763 or email me at Kevin@KPeterson.realty.
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