What You Need To Know About Property Taxes in California

Property taxes in the US are generally proportional to the value of one’s property.  The more valuable the property, the higher the taxes…

Except in California.  This is because in 1978, California enacted Prop 13 <http://en.wikipedia.org/wiki/California_Proposition_13_(1978)> which limited increases in the taxes on any individual property.

The national median property tax amount is around $1,000 per homeowner and a little below 1% of property value [see “Residential Property Taxes in the United States” by Benjamin Harris and Brian David Moore at the Urban-Brookings Tax Policy Center, 2013], though it varies enormously.  Some states have much higher property tax rates, in general, than others (bearing in mind that some states also may or may not have state income taxes, too).  New York and New Jersey have some of the highest property tax values, and as a percentage of home value, the top rates — exceeding 1.75% — are in NJ, NH, TX, NE and WI.  The lowest are in Alabama and Louisiana, with Alabama, Hawaii and Louisiana all having average rates of less than 0.35%.  Nevertheless, in California, property taxes owed, as a percentage of current property values, varies enormously from neighbor to neighbor.

In California, the median property tax rate is 0.74% of home value, and that’s just a bit under $3000 for a median home market value of just under $400,000.  [via <http://www.tax-rates.org> in Feb 2015].   

Under Prop 13, your property tax is limited to no more than 1% of the “assessed value” — but the “assessed value” is not the current market value of the property.  The assessed value is based on the market value at the time of purchase (or change of ownership), and the value does not follow the market from there – in the years following, the assessed value is only allowed to increase at the lesser of inflation or 2%.  Since property values in most of California have increased a lot faster than inflation for a long time, this means that many homes which have been owned for a long time are currently assessed, for property tax purposes, at values very much lower than their current market value — sometimes shockingly lower.  And therefore, two homes of nearly equal value, right next door to each other, may pay drastically different property taxes.

One of the consequences of this is that once one has owned a property for a long time, there’s a huge disincentive to sell it or move because wherever one moves to, one may end up with much higher property taxes, even if the new home is very much less valuable than the old one.

In addition to the “ad valorem” tax — the portion of property taxes which are proportional to the value (or “assessed value”) of the property, there may be local “parcel taxes” which are usually fixed amounts regardless of the property value.  For example, in Palo Alto, local voters approved such a parcel tax to fund the local public school system.  It’s $589/yr per parcel/property, starting in 2010, and it was approved for 6 years.  Every home in Palo Alto pays the same for this regardless of the value of the property, though there is an exemption for seniors.  Such parcel taxes, combined with the 1% ad valorem tax, can mean that the initial effective property tax rate may be well over 1% of the purchase price of the property, but since Prop 13 caps the growth of the larger part – the part based on the value of the property, over time most folks end up with property taxes quite a bit lower than that initial effective rate.

Are my property taxes deductible?  Yes, usually, mostly.  For regular taxpayers who itemize, property taxes are deductible on both federal and state income taxes.  However, if you fall into the Alternative Minimum Tax (AMT) system (a separate means of calculating income taxes which was intended originally to make sure that certain wealthier folks were still paying taxes, but which now affects a lot of middle-income people, too) — under AMT, property taxes are not deductible.  Remember, too, that when you buy a home, prorated property taxes are usually part of the closing costs — make sure to dig up those details when preparing your taxes!

What happens if you move, or remodel the house?  How about if you give or sell your home to your kids or grandkids?  Life happens and all of these are likely scenarios, and all of them can have an enormous impact on one’s property future tax liabilities.

In general, if you sell your house and move, that will mean that you’re starting over in your new home from scratch — assessed based on the market price of your new home when you buy it.  And certainly that’s the case if you move out of California.  However, there are exceptions, under Prop 60 (later added to via Prop 90) — under certain conditions, if you move within California and stay within the same county (or are in one of 10 specific counties and stay within those 10 — this is the Prop 90 extension), you may transfer your “base year value” to your new home.  There are a bunch of conditions on this, including the following: it’s a one-time thing; you or your spouse have to be at least 55 yrs old when the original property is sold; the replacement property must be your principal residence; the replacement property must have equal or lesser current market value; the replacement property must be purchased or built within two years (before or after) the sale of the original property, and a few others.

In most cases, however, moving means starting the property tax clock all over again.  This is a huge incentive to not move.  And it’s especially unlikely to help if you’re interested in moving to a bigger home.  It’s mainly helpful if you’re older and downsizing.

If you need a bigger home – for example, your family is growing — moving almost certainly means restarting the property tax clock.  But if you can either remodel your current home — or even rebuild it altogether — you may be able to keep at least some of the lower property tax base you have now.

If you remodel, in particular, if you add living space, the overall property base year assessment stays the same, but the new additional square footage will be assessed and the newly added value is added on to your base assessment.  There are a variety of issues which may affect the actual new value (i.e., “new” vs. remodeling, costs incurred during construction, sales-comparison method, etc.).  The Santa Clara Assessor’s office states that to “value new and ‘like new’ projects, the sales comparison approach is most preferred.  This involves appraising both the full market value of the property (land and improvements) as well as the market value of the land alone as of the date of construction completion.  From these two appraisals, the value of the new improvements to the property is determined.”

If you knock the house down and start from scratch, you’ll want to pay attention to the two separate parts of your property tax assessment — one part is for the structures and the other part is for the land.  The new structure will be assessed from scratch, but the land will keep its base year assessment.  This makes an enormous difference, since, especially in the most expensive areas, it’s the land which is often the most valuable part of one’s property.

However the specific new assessment is actually performed, the point is that new construction which adds value to the property will generate a supplemental assessment which represents the difference between the value existing before and after the completion of the construction.  This means, though, that the carried over base year value may still represent a huge continued savings in property taxes, especially for property that’s been owned for a very long time in an area where there’s been a lot of housing price appreciation.

Is there any way, then, to transfer ownership of the house without resetting the property tax base?  In general, a transfer to a third party (i.e., you sell your house) means that the new owner gets the property tax base value reset based on the purchase or fair market price.  However, there are two general exceptions — a transfer to children of the current owner (under Prop 58 (1986)) or to grandchildren (under Prop 193 (1996)) may allow families to maintain a lower property tax base when the property is transferred to a younger generation. There are a variety of conditions and limits on this.  If the property in question is not the primary residence, then there’s a limit of $1million.  Usually, the “Prop 13 value (factored base year value)” just prior to the date of transfer is the amount that counts towards that $1million limit.  And “children” and “grandchildren” may include step-children, adopted children, son-in-law/daugher-in-law, any child adopted before the age of 18.  For lots more details about this, see <http://www.boe.ca.gov/proptaxes/faqs/propositions58.htm>

Finally, If a property goes down in value after it was purchased, you may be able to get your assessment lowered.  The process is a Proposition 8 appeal, and it requires paying a fee and making a case for the lower value in court.  If you think the fair market value of your property is lower than the assessed value, this may be worth looking into.

The Santa Clara County Assessor’s Office makes available a “Property Owner’s Guide to Proposition 8” here:  <http://www.sccgov.org/SCC/docs/Assessor,%20Office%20of%20the%20(ELO)/attachments/Prop8_powerpoint_lowres.pdf>

As usual, this is not specific tax advice.  This is general educational material.  See a professional (accountant and/or attorney) if you want to know how or if any of this applies to your personal situation.