How does Prop 19 Affect Your Plans?
(Editor's note: This article is general in nature and is geared towards California properties. Seek professional legal and accounting advice before making any decisions).
Your primary residence is typically your most valuable possession. In Orange County, the median home price is currently around $1.3 million, and for many older homeowners their mortgage is paid off, meaning there is typically substantial equity in the property. So, what are some considerations in estate planning for this key asset?
WHO GETS WHAT?
A key aspect of estate planning is identifying assets, specifying who will get them, and achieving your goals in distributing each asset to specific heirs. See our articles on "Key Steps in Asset Distribution" and "Unequal Distribution of Your Estate."
DEBTS AND LIABILITIES
Does your home have an outstanding mortgage? Is there a home equity line of credit with a balance tied to it? See "How To Handle Debts and Mortgages In Your Estate Plan" for more information.
TAXATION
A major part of estate planning for real estate involves potential taxation for your heirs. Of course, you'd like more of your hard-earned assets to get passed on to loved ones vs. the government taking a larger share.
Tax-wise, it is important to distinguish between capital gains tax and property taxes.
Capital gains tax:
Estates of those who pass on during 2025 have a basic exclusion amount of $13,990,000 per decedent, which generally means no capital gains will be applied if the estate is less than that amount. If the home is sold, capital gains taxes are only due on any gains made since it was inherited. This involves what is called a "double step-up" in basis in a community property state: when one spouse dies, the surviving spouse receives a step-up in cost basis on the asset. After the surviving spouse passes, the asset is stepped up again. This offers great potential to reduce the amount of capital gains tax paid by the beneficiary.
Example: You decide to pass your primary home equally to your three children. Your home was purchased in 2000 for $100,000, and it was worth $900,000 on the day in 2025 that the surviving spouse died. Your heirs' cost basis will be raised, or stepped-up, to $900,000, and capital gain taxes will only be applied to the difference between $900,000 and the sales price. Of course, the final distribution amount will be determined after closing costs.
Property taxes:
Proposition 19, which took effect in 2021, has potentially severe financial consequences for children inheriting property from their parents. While this law helps eligible homeowners in transferring their tax basis, it considerably limits the availability of the parent-child exclusion for purposes of real estate tax assessments and the resulting property-taxation.
Prior to Prop. 19, parents could transfer a primary residence to children without any new fair-market reassessment, regardless of how the children chose to use the real property. So, children could have the same property tax basis that their parents enjoyed. However, with Prop 19, children who inherit real property from their parents will have to factor in increased property taxes in the decision to keep or sell the property. They may also need to use the property as their primary residence.
There are several complicated aspects involved in calculation of the reassessed value that can be excluded from the new property-tax basis, so seek professional advice.
Prop 19 now leaves heirs with just a few options, typically including:
- Sell it. This is the most common choice by heirs, especially when multiple children inherit the property.
- Live in the home. One of the caveats to avoid reassessment of value upon inheritance is the intergeneration transfer exclusion. "At least one eligible transferee must continually live in the property as their family home for the property to maintain the exclusion …"
- Use an LLC. It might be possible to transfer real estate to children without incurring a property tax reassessment by using a strategy that relies on family LLCs. However, this option has limitations and definite pros and cons (such as Change in Control Rules or the Change in Ownership Rules), so talk with a lawyer about the specifics of your situation.
WE UNDERSTAND THE IMPORTANCE OF YOUR ASSETS
At Mortensen & Reinheimer, PC we realize that your assets represent years of hard work and can hold not only financial but also sentimental value. We know that our clients may have specific goals for certain assets and beneficiaries and need legal guidance in how to best achieve these objectives. Please contact Mortensen & Reinheimer, PC at (714) 384-6053 to make an appointment, or use our online contact form. Our website is http://www.ocestateplanning.net.