Your Home = Your Wealth

For most of us, our primary source of wealth is our family home, our primary residence. Especially for Bay Area folks. We have watched our property values soar, and accordingly enjoy built up equity in our homes. The problem—if you want to call it that—is that the equity is not sitting in our bank accounts. It’s “stuck” in our homes. And we cannot access it without selling the ground on which we stand.

This means that for many of us, our largest asset is the thing we sleep in. It’s what is going to make up the bulk of our estate. So when it comes time to create an estate plan, several issues need to be addressed to have a comprehensive estate plan that will be effective when the time comes.

Is your home sentimental?

Let’s face it, unless you leave your home to someone who loves it as much as you do, they’re likely going to sell it and enjoy the cash. If your home is sentimental, or if your family legacy is tied to it, your estate plan should clearly define what your beneficiaries can–and cannot–do with the home. Can they live in it? Can they rent it out? Can they sell it? If they cannot sell it, where does the house end up when your beneficiaries die?

Do you have more than one beneficiary?

Many families leave a bulk of their estate to their children. And many families have more than one child. If you have one home, and multiple children, you don’t want to “leave it up to the kids” when it comes to the family home. What if one child wants to live in it but the other wants to cash out? Is it important to plan ahead for any increases in property taxes? Do you want to allow for either child to have the option to purchase the other’s share?

Are there competing interests for the home?

Many of us are the “‘tween” generation these days. They have little ones at home while caring for one or more aging parents. You may find yourself in a position where you want to provide a place for your parents to live, but also leave an inheritance to your adult children. If you want to keep the house for your parents to live in, have you made adequate plans for the trust to pay the expenses for the home while your parents live there? What if your children need the equity in the home to pay for college while your parents need a place to live? Which dependents get priority?

Many of us do not have adequate cash and other investments to offset distributing our entire home to one child and hope that our other children miraculously receive some equalizing gift. There are lending and other financing strategies to offset such a gift, but they need to be carefully planned for ahead of time. It’s imperative to consider your own thoughts with respect to your home, and then plan accordingly.

Avoid the Estate Planning Banana Peel – Don’t Add Your Kids on Title to your Home

Many aspects of estate planning in California center around avoiding the need for probate court. Adding a death beneficiary to an asset or adding a co-owner on title to an asset are two ways to avoid the need for probate court when you die. Well, that sounds pretty easy. Why don’t we all just do that and call it a day?

Put simply, adding co-owners and death beneficiaries to assets only addresses one situation: that 1) you have died; 2) that the beneficiary/co-owner is alive upon your death; 3) the beneficiary/co-owner has capacity and is over 18 years old upon your death; and 4) the beneficiary/co-owner does not have creditors nipping at their heels.

There are so many other scenarios that can occur. All it takes is for any one of the four factors above to be false for your simple plan to become complicated and problematic. Besides that, there are tax implications for adding people onto title of your assets.

Let’s illustrate with a common example. A widowed parent owns their own home, and has two children. The parent figures that it would simplify everything if they add their two children onto the title of the home. That way, upon the parent’s death, the children receive the home, in equal shares, without having to go through the probate process.

What gets overlooked in the above hypothetical are the following considerations.

Death v. Incapacity

The only way to avoid probate in the above example is if the parent dies. If the parent is alive but incapacitated (think: dimentia), the children have no authority to act on the parent’s behalf by simply being co-owner of the home. They now co-own a property with someone who cannot handle their own affairs. They would have needed the parent to sign other legal documents, such as a durable power of attorney.

Similarly, if either or both children are incapacitated upon the parent’s death, probate may be necessary to receive ownership of the home unless the incapacitated child signed a durable power of attorney themself. Or, if the children are not yet adults, they cannot own the property outright without legal guardians involved.

Creditors

When the parent adds the children as co-owners to any asset, including their home, the parent is entangled with that child’s financial life, including that child’s creditors. If the child is going through a divorce, or someone is suing them for money, or the child owes taxes or other debts, or if the child files for bankruptcy, then the parent’s home is now subject to the claims of the child’s creditors. The parent may have to figure out how to get their own house back!

Additionally, if the child faces those same creditors after the parent’s death, there is no barrier between receiving full ownership of the house and satisfying those creditors’ claims. Ultimately, the child may end up losing the home to their creditors, which is certainly not what the parent intended.

Creating Capital Gains and Property Tax Problems (Click here for a brief discussion of taxes)

When the parent adds their children to title, the parent is making a lifetime gift of that portion of the home. This in itself could trigger a gift tax issue. Gift tax issues aside, typically when the parent dies, all of the capital gains built into the home are eliminated upon the parent’s death. But only the capital gains associated with the portion of the home that the parent owned at death. The portion of the home that the children now own do not receive what is called a “step up in basis”, and the capital gains for the children’s portion are not eliminated. If the parent kept all 100% interest in the home, then all of the capital gains would have been eliminated. After putting their children on title during their life, the parent is now creating a capital gains problem for the children when they sell the home.

Adding multiple children to title can also create adverse property tax implications. Even though Prop 19 has severely limited the application of the parent-child exclusion, there is still an opportunity for the parent to transfer the home to one or more children with some relief from increased property taxes. However, when more than one child is added as co-owner, the home could get reassessed when one child decides to buy another out in the future since that is not a parent-child transaction.

Co-ownership and death beneficiary designations lack any nuance. It only asks whether an owner is dead, and if the answer is yes, ownership of the asset automatically transfers to the other co-owners or to the beneficiaries in whatever condition or circumstance they find themselves. No discretion is involved to determine whether it’s a “good” situation to transfer ownership of the home to the co-owner or beneficiary. Additionally, It makes you vulnerable to your co-owners’ creditors, and could create unforeseen tax issues for your loved ones. The only surefire way to transfer ownership of your assets, with nuance and full discretion, is to create a comprehensive estate plan.

Proposition 19

Californians have passed Proposition 19 with a little over 51% of the vote. It will significantly change the California property tax scheme as it applies to parent-child transactions.

There are two main components to Prop 19:

1. Over-55 Rule. The first component allows homeowners who are either over 55, have severe disabilities, or are victims of natural disasters or hazardous waste contamination to purchase a new residence and retain their property tax assessment from thier current home. In other words, you can “take” your current property tax rate with you to your next home, even if the new home is worth more than your current home. And you can do this up to 3 times in your lifetime. This provision takes effect on April 1, 2021.

1. Limited Parent-Child Exclusion. The second component dramatically limits what is called the “parent-child exclusion” from reassessment. Parents may no longer transfer unlimited amounts of property to children and escape reassessment. This one takes a bit more explanation. This provision takes effect on February 16, 2021.

A Brief Explanation of the Parent-Child Exclusion

In very broad terms, the California property tax scheme--or “Prop 13”--taxes owners of real property (the legal term for “real estate”) based on the property’s “assessed value.” To keep things simple, think of the “assessed value” as the purchase price of the property. Based on that purchase price, the tax collector imposes a ~1% tax. The property tax is not adjusted until or unless there is a “change in ownership.” When there is a change in ownership, the value of the property is reassessed. Reassessment can increase the property taxes dramatically for the new owner. 

In 1986, California voters allowed for an exception to the general “change in ownership” rule that triggers reassessment. The exception is that if parents transferred their property to their children (either by gift, inheritance, or sale), then the assessed value (i.e. property tax rate) would carry to the children. In other words, if you received property from your parents, you would continue to pay the property tax rate your parents were paying. This exception was unlimited when parents transferred their primary residence, and was limited in value when parents transferred property that was not their primary residence (e.g., vacation home, rental property, etc.).

Now let’s fast forward to February 16, 2021. When Prop 19 takes effect, the parent-child exclusion described above will be abolished. In its place will be a far more limited exception. The new exception only allows escaping reassessment if parents transfer property to their children AND the children use the transferred property as their primary residence. In other words, if the children do not live in the house and want to use it as a rental property (or keep it vacant) then the property will be reassessed. 

For example, if a parent bought a house in 1972 for $200,000, then their property tax might be $2,000 a year, regardless of the house’s increasing market value. If the parents transfer the home to a child (either gift, inheritance, or sale) after February 16, 2021, and the child does not live in the house, the property will be reassessed to its current fair market value (say $2,000,000) and the tax will jump to $20,000 a year.

Your Options Going Forward

There is no straight answer here. There are MANY unknowns at play here: the pandemic, a potential recession, other changes in the law in the near future, and particulars about your life and family. All that we know is that Prop 19 will dramatically change parent to child transfers going forward. If you were planning to leave your children property with the presumption that they would enjoy property tax savings, then you may want to consider transferring to them prior to February 2021. However, please understand that a lifetime transfer now may carry capital gains implications forward to your children. It’s a balancing act. We cannot emphasize this enough: there is no one-size-fits-all solution here. Contact us immediately to discuss your situation, things you can consider, and available options.

A side note on timing: The California election is not certified until December 11. After that, there will be regulations that are issued about how Prop 19 will be implemented and how it will work. While we can provide guidance at this point, there are still some questions outstanding that we won’t know the answers to until after that date.

What's In A Name? - Vesting Title

“What's in a name? That which we call a rose

By any other name would smell as sweet”

This quote, from William Shakespeare’s play Romeo and Juliet, has become somewhat of a cliche when we discuss form over substance.  Sometimes a name doesn’t impact the underlying substance of something. (If you call a rose “monkey,” it’s still going to smell sweet.) However, in a legal context, where words carry significant weight, a name may make all the difference.

The name on a parcel of real estate, or “title”, declares who owns a piece of property, and how those owners own the property. The following are some examples of different ways to hold title in California.

1. Property can be solely owned.

Individual or Entity

If all you see on title is an individual’s name (e.g., “Jane Smith”), or an entity’s name (e.g., “123 Main St., LLC” or “Owner, Inc.”) then that individual or entity holds complete title. There are no co-owners. Note that married individuals may own property individually (e.g., “Jane Smith, a married woman, as her sole and separate property”).

2. Property can have multiple owners, or co-owners.

Tenants in Common

If you see more than one person or entity on title (e.g., “Jane Smith and Cecilia Perez” or “Partners, LLC and Owner, Inc.”) and either a percentage ownership (“as to an undivided 25%”) or no other words, then that is referred to as “tenants in common”. This is the default method for co-ownership in California. It means that all owners have an undivided interest (meaning, there’s no boundary splitting the parcel of property) and that they’re all individually and jointly liable as owners. Each owner has the right to lease or sell their share, and when they die (if it is a person) then the property passes to their heirs.

Joint Tenants

If you see more than one person on title followed by the words “joint tenants” (e.g., “Jane Smith and Cecilia Perez as Joint Tenants”) then that means that all owners have an undivided interest (meaning, there’s no boundary splitting the parcel of property) and that they’re all individually and jointly liable as owners. However, different from Tenants in Common, the co-owners can only own equal interests in the property. A joint tenant may not have a disproportionate interest than any other joint tenant. For example, if two joint tenants own one parcel of property, then they each effectively own half. If three joint tenants, then a third, and so on. The largest benefit to this form of ownership is what is called a “right of survivorship”. This means that when one joint tenant dies, the leftover joint tenants automatically share a proportional interest in the property. For example, if “Jane Smith and Cecilia Perez as Joint Tenants” own a parcel of property, and Jane Smith dies, then Cecilia Perez is the sole owner of the entire parcel, automatically as a matter of law. If three joint tenants, then the remaining two own the property in equal shares. This form of title is only available to individuals and not to entities, since entities do not live a natural life and that right of survivorship could not apply.

Community Property

Anytime you see two names followed by the words “community property” (e.g., “Jane Smith and Cecilia Perez, spouses, as Community Property” or “Jane Smith and Rodrigo Perez, wife and husband, as Community Property”) then that means the owners are married to each other, and they are holding this property as community property. Community property is only available to married couples who reside in community property states (California, and many of the West Coast and Southwestern states) and the property is located in one of those states. Community property can also carry a right of survivorship but the words “right of survivorship” must follow the words “community property” in the title. A married person may hold title as “separate property”. If so, you will see the words “...a married person, as his/her/their separate property” following their name.

Trustee(s) of a Trust

If one or more people own property in the name of a trust, then you will see the trustee name or names, followed by the words “trustee of the [trust name] dated [trust date]”. This means that the property is held in trust and subject to the terms of that trust. (Note: The trustee of a trust can be an individual or multiple people.)

If you have any questions about title to your home with respect to your own estate plan, please contact us.