Proposition 19 recently passed in California, the results of which could mean property tax breaks for those over 55 in the state and 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 new implications.
What are the tax breaks?
For those living in California who are over 55, as well as, those with certain disabilities or who 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.
How does Proposition 19 affect my 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. Here is a short review. 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. For example: 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. If you are a married couple you can use the exemption on your first $500,000 in gains and in this example will potentially not owe any taxes on the sale of your primary home! Also, any improvement made such as updating kitchens or bathrooms, those costs get added to the original cost basis of the home purchase price years ago.
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 at the stage of thinking you will be selling your home, it is worth the time to review, plan for, and understand if you will qualify for these exemptions and what can be done to make the most of your situation.
*All information is for discussion purposes only. Please consult your tax professional for additional information.