Downsizing After 55: How Proposition 19 and Capital Gains Tax Exclusion Can Save You Money

I hear it all of the time. As my clients get older, they begin to get tired of all of the maintenance and care that is required of a large home or property and begin to consider downsizing. Several financial factors play a critical role in that decision and two of the most common considerations include understanding property tax savings under Proposition 19 (which replaced Proposition 10) and the capital gains tax exclusion for home sellers. These elements can significantly impact your move to a smaller home and I hope this guide will help to give you a broad overview of each of these legal provisions which impact homeowners and their tax liability.

1. Proposition 19: Transferring Your Property Tax Basis

Proposition 19, passed in 2020, allows homeowners over the age of 55 to transfer the property tax basis from their current home to a new property anywhere in California. Here’s how it works and why it’s beneficial:

• What is Property Tax Basis? Property tax basis refers to the assessed value of your home when you purchased it, typically subject to a 2% annual increase under Proposition 13. If you’ve owned your home for decades, this means your property taxes are likely far lower than the current market value of your home.

• How Prop 19 Helps: Prop 19 allows you to transfer your existing tax basis up to three times (or more in cases of natural disaster) to a new home. This means you can move to a new home and keep your low property tax rate, even if the new home is more expensive. If your new home is more expensive, your tax base increases only for the difference in value, keeping overall taxes lower than they would be without the transfer.

• Example: If your current home is assessed at $500,000 but is worth $1.5 million on the market, and you purchase a new home for $2 million, under Prop 19, your property taxes would be adjusted based on the $500,000 basis plus the difference between the sale price and new home price ($500,000), not the full $2 million.

This proposition can save you thousands of dollars annually in property taxes, allowing you to downsize or relocate without worrying about a major increase in tax costs.

2. Capital Gains Tax Exclusion in California

Another significant financial consideration for downsizing seniors is the capital gains tax on the sale of your home. Here’s what you need to know:

• Capital Gains Exclusion: The IRS allows homeowners to exclude up to $250,000 in capital gains for single homeowners and $500,000 for married couples when selling their primary residence. To qualify, you must have lived in the home for at least two of the last five years.

• How Capital Gains Work: When you sell your home, the capital gain is the difference between the selling price and the original purchase price (plus the cost of any major improvements you’ve made). If your gains exceed the exclusion limits, the excess amount is subject to capital gains tax.

• Example: If you purchased your home for $200,000 years ago and now sell it for $1.2 million, your capital gain would be $1 million. If you're married, you could exclude $500,000 of that gain, but you'd owe taxes on the remaining $500,000.

• Consider Deducting Home Improvements: Certain improvements like renovations, new roofs, or energy-efficient upgrades may be deducted from your gain, further reducing your tax liability. It’s important to keep records of all major improvements.

3. California’s Proposition 60/90 and Its Replacement

Before Prop 19, California’s Propositions 60 and 90 allowed homeowners aged 55+ to transfer their tax basis, but it was limited to one time and only within certain counties. Prop 19 replaced these propositions, expanding eligibility and the number of transfers. Now, downsizers can move anywhere in California, including higher-value areas, and transfer their tax base more than once.

4. Proposition 19’s Impact on Leaving Your Home to Children

Under previous laws, Proposition 13 allowed homeowners to pass their home (and its low tax basis) on to their children, even if the children used the property as a second home or rental. Proposition 19 changed this significantly.

• Limitations on Inherited Properties:
  Now, for your children to inherit your property’s low tax basis, they must live in the home as their primary residence. If they decide to use it as a rental or vacation home, the property will be reassessed at market value for tax purposes, meaning they could face significantly higher property taxes.

• Exemption Limits:
  Even if your children inherit the property and use it as their primary residence, the tax basis can only be transferred up to a certain value. If the difference between the current market value and your tax basis exceeds $1 million, the excess amount is added to the tax base.

• Example:
  If you pass on a home with a tax basis of $500,000 and it is worth $1.7 million at the time of inheritance, your child can inherit the home with the original $500,000 tax basis, plus the amount that exceeds the $1 million threshold. In this case, they would be taxed on $700,000 of value ($1.7 million minus $1 million threshold).

5. Estate Planning and Long-Term Financial Health

Downsizing can also affect your estate planning strategy:

• Gift Tax Considerations:
  If you’re planning to give some of the proceeds from selling your home to your children or grandchildren, be mindful of federal gift tax laws. As of 2024, you can gift up to $17,000 per year per recipient tax-free. Consult a tax professional to explore ways to minimize your tax burden through gifting.

• Inheritance Considerations:
  It’s essential to consider how downsizing and selling your home fit into your overall estate plan. By unlocking the equity in your current home, you can improve your financial liquidity and potentially pass on more assets to your heirs. However, the new Proposition 19 rules may complicate the transfer of property tax benefits to your children, so discussing these changes with an estate planner is crucial.

6. Healthcare and Lifestyle Needs in Retirement

As you downsize, it’s important to consider the impact on your lifestyle and long-term healthcare needs:

• Mobility-Friendly Living:
  If you’re planning to age in place, look for homes with accessibility features like single-level layouts, wide doorways, and walk-in showers. Downsizing can be an opportunity to future-proof your living situation.

• Proximity to Healthcare:
  As you age, being close to medical facilities and healthcare providers becomes increasingly important. Be sure to factor this into your choice of a downsized home.

• Community and Social Life: Downsizing may also mean relocating to a new community. Consider areas with strong senior support systems, social opportunities, and recreational activities that align with your lifestyle.

Conclusion

Downsizing in Napa Valley offers baby boomers the chance to reduce costs, simplify their lifestyle, and take advantage of financial benefits like Proposition 19 and the capital gains tax exclusion. However, it’s crucial to understand how Proposition 19 impacts property tax transfers, especially when passing your home to your children, and to incorporate estate planning into your downsizing strategy.

If you’re considering downsizing and want expert guidance on navigating these financial considerations, be sure to consult with a qualified estate planning attorney. Need recommendations? I’m here to help. Let’s work together to make your transition seamless and financially beneficial.

Disclaimer:
I am a licensed real estate professional, not a certified estate attorney or tax advisor. The information provided in this post is for general informational purposes only and should not be considered legal, financial, or tax advice. For personalized guidance on tax laws, estate planning, or financial matters related to downsizing, please consult a qualified estate attorney or tax professional.