California is the only state to allow for a tax break that limits property taxes and extends those advantages to inherited property, whether or not it is used for rental income. Since 1978, Proposition 13 has strictly kept property tax bills low. Eight years later, another tax break was implemented under which Proposition 13 also extends to inherited rental property.
Protection for Children From High Tax Increases
The purpose of this tax break is to protect families from having to pay steep tax increases when a loved one passes. Without the tax break, the amount of taxes could be so large that adult children who inherit property from their parents would be unable to live in the family home. However, analysis conducted by the Los Angeles Times showed that a large amount of those inheriting property do not actually live in it, but rather rent it out for additional income.
Inherited Properties Used for Rental Income
It was shown that in 2017, up to 63 percent of all homes inherited under the system were not in fact lived in, but rather used as rental properties or second residences. Coastal areas in Sonoma and Santa Cruz have some of the highest concentration of these beneficiaries.
Even more interesting is the fact that beneficiaries need not even live in California. There have been cases of individuals living in one state and still renting their inherited properties from across the country.
Inheritance Tax Break Found to Cause Major Problems
While all of this break may seem extremely positive and beneficial, there are certainly some major cons with it. The inheritance tax break has allowed for hundreds of thousands of individuals to avoid paying the same higher taxes that newer homeowners are required to pay. Due to the tax break, cities, counties, and school districts have been deprived of billions of dollars in revenue, which could otherwise be put back into the community. Since there is no limit on how many descendants are able to access this benefit, generations of Californians will continue only having to pay property taxes based on the market values of the homes back in the 1970s. In many cases this is the difference in hundreds of thousands of dollars in property taxes should they have been reassessed at the time of the inheritance.
While this has been very beneficial for many families, the rapidly soaring cost of property values in California has also created unexpected consequences: major premiums for longtime homeowner families – something that was not anticipated by the supporters of this law.
Proposition 13 has unintentionally created further inequities between those who owned property within the family and those who have not. Former state assemblyman and author of the tax breaks, Thomas Hannigan, admitted to not having foreseen the law to be used as a windfall. “I tried to do the right thing,” he said. “Obviously it had unintended consequences.”
Posted in: Estate Planning