What are “ad valorem” taxes?
Prop 13 and Prop 19 are centered on “ad valorem” property taxes. “Ad valorem” is simply Latin for “according to value.” As such, ad valorem property taxes are just ordinary property taxes. They are a tax levied by the state government against owners of real property on a year-to-year basis.
But ad valorem taxes are not static. For example, in California, the sales tax rate is at least 7.25%, though it can be higher depending on where one is located. With the sales tax, quantity and quality do not matter. Buying 100 apples versus only 1 will not change the 7.25% tax on the sale.
Ad valorem taxes, on the other hand, are in a constant state of flux. Quality does matter, as the amount of the tax is proportional to the value of the thing against which the tax is assessed. Thus, a home worth 500,000 will incur a smaller tax than one worth 50,000,000.
What is Proposition 13?
To understand the true scope of Proposition 19, one must first realize the effect of Proposition 13. Prop 13, colloquially known as the “Howard Jarvis Rule” is perhaps the most important piece of legislation affecting real estate in California. If you own a home, you have probably heard of Prop 13.
As an official amendment to the California Constitution back in 1978, Prop 13 changed the way that the state approaches ad valorem property taxes.
What it first did was establish a “base year” for every piece of non-exempt property, so that the value of each piece of property was equal to what it was in 1975. Second, it restricted rates of increase on assessments to 2% at the maximum. Third, and most importantly, Prop 13 limited property taxes to 1% of the assessed value of the home.
So, for example, in 1978, a home is worth $500,000 (it’s 1975 value). The next year, after the owner (“Bob”) builds some substantial improvements, a local appraiser assesses the value to be $600,000. But for the purposes of property taxes, the assessment value of the property can not exceed that 2% threshold. Thus, property taxes in 1979 would assess the property’s value at only $510,000, because the value of the home could only increase by 2%. After that, the county would charge a tax at a maximum of 1% of $510,00.
The next year, the cycle would continue. Regardless of the home’s actual value on the open market, the assessed price of the home in 1980 could not increase by more than 2% of $510,000.
Proposition 13 Reassessments
Unfortunately, the Prop 13 described above is only half the truth. And that’s because the “base year” can change. It would be the “appraised value of the property when purchased, newly constructed, or a change in ownership has occurred.” (County of Orange v. Bezaire (2004) 117 Cal.App.4th 121, 133.)
Take the example of Bob above. Recall that in 1979, the actual value of his home was $600,000, but the assessed value for his taxes was only $510,000. Suppose that in 1980, Bob actually sold his house to “Jim.” Jim would not inherit the tax value of $510,000 because there was a change in ownership. Instead, when Jim would need to pay taxes in 1980, the assessed value for his property taxes would be the actual value of the home. The new “base year” would be 1980.
If you’ve ever wondered by you’re paying so much more in property taxes than your neighbors, this is why. Homes with identical prices on the market could have wild disparities in the amount of taxes being assessed against them because one owner’s base year is 2023, while the other’s is still 1975.
What is a Change in Ownership Under Proposition 13?
The main crux of Prop 13’s reassessment trigger is still, today, “change in ownership.” But that term is somewhat ambiguous. In fact, Prop 13 did not bother to define “change of ownership” when it was initially passed. (Reilly v. City and County of San Francisco (2006) 142 Cal.App.4th 480, 487.)
As such, the voters returned to this topic in 1986 by passing Proposition 58. Under Prop 58, “purchase” and “change in ownership” did not include the purchase or transfer of the principal residence of the transferor in the case of a purchase or transfer between parents and their children, and the purchase or transfer of the first $1,000,000 of the full cash value of all other real property between parents and their children. (Cal. Const., art. XIII A § 2, subd. (h).)
Put simply, if parents transferred their home to their children, it would not trigger reassessment.
How did Proposition 19 Change Proposition 13?
Prop 19 changed the above rule drastically. First, the inherited property needs to be used by the inheritor as the primary residence. So, for example, if Bob in the example above instead gave his house to his son, but his son already had a home and wanted to use Bob’s house as a vacation residence or to rent out, that would trigger reassessment even though it was an intra-family transfer of Bob’s primary residence to his kid.
But second, and more impactfully, Prop 19 caps the relief that Prop 13 previously provided to the assessed value, plus one million dollars. In other words, the property taxes increase if the value of the property exceeds the property’s taxable value by more than one million dollars.
For example, let’s revisit Bob. Suppose that by 2023, his home is worth $5 Million. But his assessed value for taxes at this point is only $600,000. When he leaves his house to his son, the son is protected up to the base value, plus one million. That totals 1.6 million free from reassessment. But the remaining 3.4 million is subject to reassessment.
How does Proposition 19 affect primary residence transfers?
Despite the significant effect that Prop 19 poses on transfers between family, there is a silver lining. If a resident is over the age of 55, and the victim of a wildfire or natural disaster, or severely disabled, then they are permitted to transfer their assessed property value to another primary residence on three separate occasions. Under prior law, similar residents could do this only once per lifetime.
How the Lawyers at the Underwood Law Firm Can Help
As many parties are finding that Proposition 19 will significantly affect their ability to transfer property to family, they are searching for answers. These situations can be stressful, and difficult, especially when the way out is not entirely clear. Fortunately, the lawyers at the Underwood Law Firm specialize in partition actions and solving difficult co-ownership problems, and helping good people end bad real estate partnerships. If you have found yourself in one of these situations, then please do not hesitate to contact us today.