November elections are on the horizon and that means California voters will again vote on a several propositions that could radically alter the legal landscape in the state, including the state Constitution. Among the propositions on the ballot this year are Propositions 15 and 19, two real estate taxation measures that would, among other things, result in substantial changes to taxes on business property and intergenerational property transfers in California.
Proposition 15: Tax on Commercial and Industrial Properties for Educational and Local Government Funding
Proposition 15 would require many commercial and industrial properties in the state to pay property taxes based upon their property’s fair market value. Residential properties would continue to be taxed at their purchase price. The proposition exempts property zoned as commercial agriculture, properties whose owners have $3.0 million or less in holdings in California, small business tangible personal property and $500,000 in value for non-small businesses tangible personal property.
State fiscal analysts estimate that from $8 to $12.5 billion would be generated from the Prop 15 market value tax that could be devoted to local government spending and the budgets of educational institutions, including K-12 schools and community colleges.
Proposition 19: Property Tax Transfers, Exemptions and Revenue For Wildfire Agencies and Counties Amendments
Proposition 19 would allow eligible homeowners to transfer their tax assessments to a home purchase anywhere within the state and it would also permit tax assessments to be transferred to a more expensive home along with an upward adjustment. Prop 19 would also increase the number of times (from one to three) that persons over 55 years of age or persons with severe disabilities could transfer a tax assessment. “Inherited homes” not used as principal residences, such as second homes or rentals, would, however, now be reassessed at market value at the time of transfer.
All of the additional revenue or net savings that would result from the changes to tax assessments under Prop 19 would be devoted to fund wildfire agencies and local counties.
Criticism leveled at both Proposition 15 and 19 is substantial. As might be expected, in one large camp opposed to both of the Propositions are the “anti-new tax advocates” who argue that property taxes in California are already through the roof, primarily due to the state’s inability to properly manage its financial resources. New market-based property taxes would, according to the ‘no new taxes’ group discourage businesses from bringing and keeping their operations in California and changes to property tax transfers will clamp down on family real estate gifts that preserve wealth and allow it to pass from one generation to the next.
Putting aside the benefits that might be achieved by funding schools and wildfire agencies, Proposition 19 in particular carries with it some far reaching changes that radically alter how property taxes are handled in California.
Propositions 13 and 58: Historical Promises Now Undone by Prop 19?
For some historical context, one should recall that, in 1978, Proposition 13 was passed, arguably giving state residents some certainty that their future property tax liability would be capped at 2% per year in ‘taxable value’. Residential, commercial, and industrial property would be reassessed at market value only when it changed hands. Then in 1986, Proposition 58 was passed to prevent families from getting blasted with big tax increases allowing homes up to a million dollars of assessed value to pass between parents and children without any property reassessment.
Practical Impact on the Loss of Proposition 13 Protections
Taking a practical look at the impact of losing Prop 13 protections, suppose a business owner paid a million dollars for a parcel in 1980. Prop 13 allows a 1% property tax assessment on that purchase- a $10,000 tax charge in our example. Prop 13 also limited any future increase to a max of 2% annually. As such, the property would be assessed at about $2.2 million for tax purposes, resulting in a property tax bill of approximately $22,000.
If Prop 13 protections disappear under new Prop 19, the business owner’s commercial property would now be assessed at current market rates (suppose about $6 million in our example). Now the owner’s property tax bill jumps an extra $38,000 per year and he could be subject to a current market value reassessments every three years.
Intergenerational Property Transfers Under Attack
Under Proposition 19, the claimed repeal of the “intergenerational transfer protections” would, according to the legislature’s analyst’s office, result in 40,000 to 60,000 families seeing higher property taxes every year. The ‘trade off’ under Prop 19 is that older homeowners could move to a replacement home and transfer the property tax from their older home to the new property, a proposal that was previously rejected by the state voters in 2018.
Currently, parents and grandparents can transfer primary residential homes to their children or grandchildren without incurring a ‘reset’ of the property tax value to market rates. In addition, vacation home and business properties can similarly be transferred at lesser property tax rates because the first $1 million in value is exempt from any reassessment at the time of transfer.
Proposition 19 would eliminate the safe haven of the residential tax transfer unless the child uses the property as their principal residence – that is, using it as a rental property or second home would trigger the reassessment. Even those inherited homes used as a principal residence would see property tax readjustments each year at a rate equal to the change in the California House Price Index as of February 16, 2023 under Prop 19.
While it is hard to argue against the need to provide greater funding for education and for fighting state wildfires, the voters of California will need to decide in November if Propositions 15 and 19 are the appropriate mechanisms to accomplish those objectives. For parents and grandparents considering intergenerational property transfers, big changes may be on the horizon that could substantially alter your estate gifting. Cast your vote in November, keep an eye on the outcome and get ready to change your estate plans.