Since its passage in 2020, Proposition 19 has stirred significant controversy, primarily because it drastically altered California's property tax laws. These changes have profound financial implications for all property owners, including business owners. In this article, we'll review the major changes brought about by Proposition 19, discuss the impacts on business owners, and explore some potential opportunities.
Increased Property Taxes on Inherited Properties
- One of the most contentious aspects of Proposition 19 is the change in how inherited properties are taxed.
Elimination of Exemptions
Proposition 19 eliminates any exemption on the parent-child transfer of real property other than the primary residence. Children will not be able to inherit real property other than primary residence from their parents without reassessment at current fair market value at the time of transfer. This means that if you have a vacation home or rental property that you want to transfer to your children, they can now be liable for a considerable tax burden once they gain ownership.
As for the primary residence (family home or family farm) transfer between a parent and a child, the exemption remains – but with the following restrictions:
- The child qualifies for the exemption only if they continue using the transferred property as their primary residence. Moreover, they must move into the property within one year of the transfer.
- Once the condition mentioned above is established, the child’s taxable value is determined based on whether the property’s assessed value (current fair market value) at the time of transfer exceeds the parent’s taxable value by over $1 million. If the property’s assessed value at the time of the transfer doesn’t exceed the parent’s taxable value by $1 million, then the child assumes the parent’s current taxable value. However, if the contrary happens, then the child’s taxable value is the current assessed value of the property minus $1 million.
Impact on Family-Owned Properties
Financial Burden
- Families that own businesses and wish to pass them down to the next generation may face higher property taxes. This can significantly impact the financial viability of continuing the family business. Critics argue that this change could harm small, family-owned businesses that are integral to local economies.
Shift in Tax Burden
- Proposition 19 is seen as shifting the tax burden unfairly. While it provides benefits to certain groups, it imposes potentially substantial financial burdens on heirs, particularly those inheriting family businesses that own the commercial property where the business operates.
Influence on Inherited Properties
- For business owners planning to pass their properties to their heirs, the new rules mean that their heirs could face significantly higher property taxes. This might force heirs to sell the business property if they cannot afford the increased taxes.
Despite the challenges, Proposition 19 also presents some opportunities for business owners.
Portability of Property Tax Base Year Value
- Tax Savings and Flexibility
- One significant advantage is that property owners who own their primary residences can now transfer their property's tax assessment value to a new home. This is particularly beneficial for business owners who are 55 years or older, severely disabled, or victims of natural disasters. They can transfer their existing low property tax base up to three times (previously limited to once) to a new primary residence anywhere in California. For business owners, this can result in substantial property tax savings and provide more flexibility in relocating, potentially freeing up capital for reinvestment in their businesses.
Impact on Real Estate Market
- Market Adjustments
- The reassessment rules could influence the commercial real estate market, potentially leading to a decrease in the number of family-owned business properties being transferred without a sale. Business owners might see shifts in property values and rental prices as the market adjusts to these new tax implications.
Financial Planning and Strategy
- Estate and Succession Tactics
- Business owners will need to reconsider their estate and succession planning strategies. The increased potential for higher property taxes on transferred properties necessitates new approaches to manage the financial implications. This could include setting aside funds for future tax payments or reevaluating how they own their real estate.
What’s Next?
Proposition 19 brings significant changes to property tax laws in California, creating both challenges and opportunities for business owners. By understanding these changes and proactively adjusting financial and estate planning strategies, business owners can navigate the new landscape and potentially mitigate these significant tax increases.
How Wealth Advisory Lab Can Help
As business owners with years of experience, we understand that legislative updates may have an impact on your business. Our goal is to minimize unwanted results. To reach your future state, we have found our strategies often serve as guardrails, ensuring your vision for yourself, your family, and your business is 100% coordinated with your planning.
Contact us today to learn how we can help you navigate the complexities of Proposition 19 and optimize your financial planning strategies.