By Michael Repka, Esq. (LL.M. (Taxation) — NYU School of Law)
Since the passage of Prop 13 in 1978, California property tax on newly acquired property has been calculated based on the value of the property on the date of purchase. Although this value is adjusted every year, it can never increase more than 2% per year.
Given that California real estate prices have increased, on average far more than 2% per year, long-term homeowners often pay property taxes on a value that is much less than the fair market value of their property. When the property is resold, the tax value is reset to fair market value. This results in a significant disadvantage to taxpayers who sell a property that they have held for a long time to purchase a replacement property at current prices.
Propositions 60 and 90
In an effort to help senior citizen homeowners who want to downsize their principal residence, while still preserving their low property tax, voters passed Proposition 60 in 1986. Under Prop 60, taxpayers who are 55 years of age or older can make a once-in-a-lifetime election to transfer their low property tax to a new residence, provided that the replacement property is of equal or lesser value and is located in the same county.
Over the years, this benefit has been expanded to include moves necessitated by severe and permanent disability (Prop 110) and transfers between parents and children (Prop 58) and grandparents and grandchildren (Prop 193).
Prop 90, passed in 1989, expanded this taxpayer-favorable rule to include replacement properties in a limited number of other counties, provided those counties agreed to allow the transfer, and if the other requirements outlined in Prop 60 are met. In other words, this is still a once-in-a-lifetime benefit that only applies if the replacement property is of equal or lesser value.
Although the list periodically changes, the counties that currently allow Prop 90 transfers are:
- El Dorado
- Los Angeles
- San Bernardino
- San Diego
- San Mateo
- Santa Clara
- Tuolumne; and
New Proposal for “Portability”
In large part thanks to the lobbying efforts of the California Association of Realtors® and the Howard Jarvis Taxpayer Alliance, there is a now a new initiative that would dramatically expand seniors’ ability to transfer their property tax to a new home. This proposal varies from Prop 60 in three significant ways:
- Statewide application – the replacement property can be located anywhere in California;
- Unlimited usages – Taxpayers would be able to take advantage of this rule multiple times, rather than just once in a lifetime; and
- The replacement property would not have to be less expensive than the original property. Taxpayers buying more expensive replacement property would get the benefit up to the value of the original property and any excess would be added to the taxable value.
Let’s look at a simple example of how the new “portability” proposal differs from the current Prop 60. Assume a homeowner who is over 55 years of age owns a home that is worth $3 million, but they are paying tax on a value of only $1 million because they purchased the home in 1982. Assume further that they find a home that they would like to buy for $3.5 million. Under the current Prop 60, the homeowner cannot buy the new home and transfer their property tax to it because the value of the acquired property would be more than the value of the old property. As such, they would have to pay property tax on the full $3.5 million. Under the new “portability” proposal, if they were to purchase a new home for $3.5 million and then sell their old home for $3 million, then they would pay tax on only $1.5 million (the original tax value of $1 million plus the $500,000 that the new value exceeded the old value).
Potential Benefits to Portability
Currently, many long-term homeowners are reluctant to sell their highly-appreciated property due to the adverse tax consequences. The most immediate and onerous tax consequence is the capital gains tax, which can be as high as 37.1%, when both federal and state taxes are considered. To add salt to the wound, the Seller could see a significant increase to their annual property tax bill. As a result, many homeowners feel captive and decide to age in place.
While the proposed “portability” legislation does nothing to alleviate the capital gains tax bite, the ability to transfer the Seller’s low property tax basis could encourage more homeowners to sell due to their ability to preserve the Prop 13 benefits. This would provide more available homes to people looking to buy in the area.
Potential Disadvantages to Portability
If the California Association of Realtors® is correct in its projections that more homeowners will decide to sell as a result of this proposed expansion, then the increase in inventory could result in downward pressure on housing prices due to the economics of supply and demand. To local homeowners, that would be bad news. However, this could be considered good news to buyers facing the affordability crisis.
Perhaps the strongest opponent to portability are California cities and counties themselves. Naturally, any aggregate savings to taxpayers would come at the expense of local government’s budgets.
While it is still too soon to know whether these changes will be enacted, they could represent the most significant changes to California property tax since the late 1980s.