There is a difference between property tax and tax basis.
Do you own a home in California?
If so, you may be a little confused by the laws regarding transferring homes between parents and children.
According to a recent San Francisco Chronicle article titled “Taxes on a home can be confusing: Here’s how to keep them straight,” California has a law letting parents transfer homes to their children without requiring a property tax reassessment.
The parents can either transfer the home while they are living or pass it through their estate after they die.
Is there a benefit to doing one over the other?
If you pass the home while you are alive, your child will only have the benefit of the property tax not being reassessed.
If you pass the home as an inheritance, the child will receive a property tax benefit as well as a step-up in basis.
A step-up in basis is a significant tax break, making the latter option better financially for your child.
What are the differences between a “property tax base” and a “cost basis”?
The property tax base is determined by state law.
In California, the assessment is made when you purchase a home plus an inflation factor of no greater than 2 percent a year plus the value of major improvements.
The value of property in California will raise significantly over the years after it is purchased.
Having no reassessment saves a lot of money.
Your child could even pass your property to your grandchildren with the same low property tax.
This is made possible through Proposition 58.
Property tax breaks can be used only once in a lifetime.
A California homeowner age 55 or older can sell his or her primary residence and transfer the assessment to a new home of equal or less value if it is in the same county or in a county accepting incoming transfers.
Can this change?
Proposition 5 would allow seniors to transfer their property tax base to a replacement home of any value in any county in California with no limit to the number of times this is done.
If the new home is more valuable, the difference in price would be added to the assessment of the new home.
If the home is of lesser value, the assessment would be reduced.
This is up for vote in November.
Cost basis, unlike the property basis, is used for income tax purposes.
For income tax purposes, the tax basis on your home is usually what you paid for it plus the cost of major improvements if you have never rented it out.
If you sell your property for more than the cost basis, your profit will be taxed as capital gains.
If you have lived in the home as your primary residence for at least two of the past five years, you will be exempt the first $250,000 in capital gains if you are single and $500,000 if you are married.
If you purchased the home in a 1031 exchange and convert the rental property to a primary residence you must live in it for at least two of the past five years and own it for at least the past five years to receive the capital gains exclusion.
If you still own the home when you die and pass it to your child, he or she could receive a great capital gains tax break.
Appreciated assets receive a “stepped up” cost basis when you die to the market value on the day you passed away.
This means there will be no taxes on appreciation during your lifetime.
If your child sold the home immediately, they would face very little to no capital gains tax.
Your child could also take advantage of the capital gains exclusion if he or she meets the primary residence requirement.
Another thing to consider if you intend to pass your house to your child is gift tax.
If you pass your home or part of your home while you are alive, you will need to file a gift tax return on the part exceeding the annual gift exclusion.
This reduce your combined lifetime gift and estate tax exemption of $11.18 million for singles and $22.36 million for couples who die in 2018.
What if you own the home as community property?
If one spouse dies, the entire home enjoys a step-up in basis.
It will receive a step-up again when the second spouse dies.
Note: In Kansas and Missouri only one-half of the home value would receive that step-up at the first death.
Planning ahead with an experienced estate planning attorney could save you and your heirs both time and money.
Reference: San Francisco Chronicle (September 1, 2018) “Taxes on a home can be confusing: Here’s how to keep them straight”