Property taxes are set to change in California. The passage of Proposition 19 in California creates property tax breaks for those over 55 in the state. It also creates potential tax increases for those inheriting homes from their parents or grandparents. For those homeowners thinking of downsizing, or those thinking their children will one day inherit their home, this law has a few implications
Property tax for Californians
California residents over age 55, those with certain disabilities, people that lost their home due to wildfires or natural disasters, you can now sell your home and transfer your current property tax base to a new property anywhere in California of equal or lesser value. When you buy a more expensive home than what you sell your residence for, there will be a smaller adjustment up of tax basis than what would have happened prior to Proposition 19. In addition, you can do this tax basis transfer a total of three times. This is a big change for people looking to downsize.
As many people begin thinking about their retirement planning in San Diego, the idea of downsizing is often a major discussion. Whether people want to get equity out of their home, have less maintenance, or just move to be closer to family, downsizing can have a number of benefits for retirees. Before this proposition, one major drawback to downsizing was losing your original tax basis on your home. People would be moving into a smaller and less expensive home but often seeing their property taxes double. Proposition 19 removes that worry for those over 55 now.
Proposition 19 impact on estate planning
If an owner gifts, sells or transfers through inheritance a home to a child or a grandchild and they proceed to use it as their primary residence, barring a few situations based on property sale value, there is no change. They get to keep the original tax basis on which your property taxes have been based on. However, if they use it as a rental, second home, or anything other than a primary residence, then a new tax assessment will occur based on the current market value of the home and their property taxes will potentially have a big increase. This has a big impact, as many of the popular coastal cities in California see upwards of 60% of inherited homes being used as rentals or second homes.
How does capital gains work on a home sale?
The tax brackets for capital gains were not changed from Proposition 19. Selling a primary home you have lived in for 2 of the last 5 years gives you a big tax benefit. Selling a home is like selling a stock, if you made money, it will be taxed as a short term gain if you sold it within a year or a long term gain if you sold it after holding it for over a year. The difference is when selling a home, each taxpayer gets an exemption from paying tax on a certain amount of gains. That exemption is $250,000 for a single tax filer and $500,000 if married or filing a joint tax return.
If you bought your home years ago for $500,000, and now sell it for $1,000,000, you would have a long-term capital gain of $500,000. A married couple you can use the exemption on their first $500,000 in gains. In this example they will potentially not owe any taxes on the sale of their home! Also, the costs of improvements made such as updating kitchens or bathrooms get added to the original cost basis.
Does this potential tax break on your property tax make you more interested in selling or downsizing? Let us know if we can help you understand your options. If you are thinking of selling your home, it is worth the time to review, plan for, and understand if you will qualify for these exemptions. Taking the time to plan for a home sale is time well spent. You can save on both capital gains and property tax if done properly.
*All information is for discussion purposes only. Please consult your tax professional for additional information.