If you enjoy low property taxes on your California real estate, and you want your children to inherit your assessed value, consider making an advance of their inheritance this holiday season.

Current law (enacted by Proposition 58) allows parents to transfer to their children without property tax reassessment:

1. Their primary residence of any value; and
2. Up to $1 million assessed value (regardless of fair market value) of other real estate, including vacation homes, rental properties, and businesses.

However, with the recent passage of Proposition 19, the law will change on all transfers beginning February 16, 2021. As a result, the parent-child reassessment exclusion will be limited to the parent’s primary residence, the child must occupy the property as his/her primary residence, and only the first $1 million differential between assessed value and fair market value will escape reassessment.

Before you start feeling too generous, consider these potential drawbacks of lifetime gifts:

1. Mortgaged property cannot be transferred without violating the lender’s due-on-sale clause. The mortgage may need to be paid off or assumed by the beneficiary.
2. A lifetime gift of this magnitude will necessitate the filing of a 709 federal gift tax return. While no gift tax need be paid now, you will lose part of your $11.58 million estate tax exemption. (This is generally considered a good use of your “unified credit” as we the gift and estate tax exemptions will likely be reduced in the near future.)
3. Property gifted during your lifetime passes with your carryover basis whereas inherited property currently qualifies for a stepped up basis. If the beneficiary will sell the property, an inheritance may be in his/her favor to reduce capital gains tax exposure.
4. Once you make a gift, it is out of your hands. You cannot retain rental income or mandate a right of occupancy. Outright gifts may be subject to claims by the beneficiary’s spouse and creditors.

Here’s an example of how this all plays out:

Assume that Mom’s principal residence has an assessed value of $200,000 and a fair market value of $2 million. She also owns a vacation home with an assessed value of $300,000 and a fair market value of $1.5 million. Mom pays property taxes of roughly $5,000/year. She has one child (“Child”).

If Mom passes away this year, leaving her principal residence and vacation home to Child, both properties qualify for the parent-child reassessment exclusion. There is no limit on the reassessment exclusion for the principal residence. The vacation home’s assessed value of $300,000 is well below the $1 million assessed value that may transfer to Child free from reassessment. Furthermore, there are no restrictions on Child’s use of these properties. Child continues paying property taxes of $5,000/year.

Similarly, if Mom gifts her real estate Child this year, both properties qualify for a full reassessment exclusion.

But if Mom passes away on or after February 16, 2021, her principal residence will be reassessed by at least $800,000, assuming Child will make this his/her primary residence. If Child will not occupy this property, it will be subject to a $1.8 million reassessment. The vacation home will definitely be reassessed by $1.2 million. Accordingly, Child inherits a property tax bill of $20,000-$30,000/year.