Inherited property that isn't used as a primary residence will be reassessed to a new tax rate.
By JEFF LAZERSON | firstname.lastname@example.org | MortgageGrader.com | May 30, 2023
Article originally posted in Orange County Register on May 26, 2023.
My parents bought an Anaheim home in 1963 when the family moved from a Los Angeles apartment.
They used Dad’s VA benefits to buy a three-bedroom, one-a-half-bath home just west of Disneyland, paying roughly $12,000.
Cancer took Mom’s life some 32 years ago. Dad died last summer.
Dad’s annual property taxes were a minuscule $1,043 at the time of his passing. That’s less than $87 per month. Had his children kept the home as a rental property, they would have been faced with a lofty property tax increase of about $8,600 annually. Said another way, net monthly rental income would have been reduced by $630 ($717 for the new tax rate minus the $87 monthly tax rate Dad paid).
Using my dad as an example, Proposition 19 has evolved into nothing short of a financial gut punch for parents who had planned on passing along California real estate rentals to their children under the auspice of Proposition 13 (passed in 1978). Prop. 13 capped at 2% any annual property tax assessment increase for every piece of California real property, owner-occupied, investment (including commercial and farms for example) and second homes.
Let’s assume there is no primary residence exemption at hand. In this case, the heir child/children must move into the property within one year from the date of death and file for a homeowner’s property tax exemption under Prop. 19, which voters approved in 2020 and became effective Feb. 16, 2021. Under the new law, property taxes for inherited investment property are reassessed based on the date of death of the last living parent.
Ben Schwefel, law partner at Irvine-based Murtaugh Treglia Stern & Deily LLP explained to me a workaround parents might be able to use to protect their children from the rental property tax reassessments built into Prop. 19. (Full disclosure: I do business with the Murtaugh Law firm for which Mr. Schwefel works.)
I am going to oversimplify the steps necessary. A word of caution: Do not attempt this on your own. Seek experienced legal counsel from a California-licensed estate planning attorney.
Let’s say your dad and mom own a rental property. They have a son and a daughter. The parents create a limited liability company, known simply as an LLC. Parents transfer the rental property into the LLC. (This is usually done for investment properties and second homes.)
The parents gift a 25% interest in the LLC to their son and a 25% interest to their daughter. The parents keep a 50% stake.
Sometime later mom, dad, son and daughter create a second limited liability company to hold their shared investment. These steps gradually shift the ownership from one party to another, keeping a tax reassessment at bay.
After another period, mom and dad gift their remaining 50% interest to son and daughter. Parents end up with zero interest. The son and daughter each end up with 50% interest in the family’s second limited liability company. The situation is more complex if just one child is inheriting the property, and a smaller tax reassessment is likely, according to my sources.
“When done the right way, this strategy may enable families to pass properties to the next generation without reassessment,” said Schwefel. “For families solely focused on preserving low property taxes, this may be the way to go. For many families, there are other considerations to take into account like income tax, gift tax and estate taxes.”
While not providing a substantive analysis of the strategy, Peter Kim, chief communication officer at the California Board of Equalization did not say this workaround could be banned under the law.
Investment property stakeholders may experience different tax outcomes depending on the county in which the property is located. In other words, one tax assessor in one county could be good to go. Another county assessor could seek to disallow the transaction resulting in property tax reassessment, according to Schwefel.
More than two years into Prop. 19, it’s safe to assume many California real estate rental property heirs have made decisions to sell the properties because they can’t afford to pay the higher property taxes or it no longer makes financial sense to keep the rentals.
I have heard from countless column readers about this dilemma, many of whom never knew or understood Prop. 19’s consequences to them. At least one lawmaker in Sacramento is trying to unwind the mandates for investment property under Prop. 19.
Freddie Mac rate news: The 30-year fixed rate averaged 6.57%, 18 basis points higher than last week. The 15-year fixed rate averaged 5.97%, 22 basis points higher than last week.
The Mortgage Bankers Association reported a 4.6% mortgage application decrease from last week.
Bottom line: Assuming a borrower gets the average 30-year fixed rate on a conforming $726,200 loan, last year’s payment was $681 less than this week’s payment of $4,624.
What I see: Locally, well-qualified borrowers can get the following fixed-rate mortgages with one point: A 30-year FHA at 6.25%, a 15-year conventional at 6%, a 30-year conventional at 6.5%, a 15-year conventional high balance at 6.625% ($726,201 to $1,089,300), a 30-year high balance conventional at 7% and a jumbo 30-year fixed at 6.625%.
Note: The 30-year FHA conforming loan is limited to loans of $644,000 in the Inland Empire and $726,200 in LA and Orange counties.
Eye catcher loan program of the week: A 30-year VA fixed rate at 5.5% with 2 points cost.
Jeff Lazerson is a mortgage broker. He can be reached at 949-334-2424 or email@example.com. His website is www.mortgagegrader.com.
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Jeff Lazerson - Mortgage Columnist since 2011