When I was growing up, my father used to say, “Anything new is going to start in California”. While this may not be entirely true, it was true about the tax revolt that would surge out from California on populist voter sentiment and echo geographically and over the course of time. I wasn’t of voting age when Proposition 13 was passed in 1978, but I was old enough to know it was a watershed political legacy and it continues to be a force that affects us today even 38 years later! Funny enough, guess who was governor at the time? Yep, Jerry Brown!
Sitting across from an excited new millennial buyer, who was closing on her very first home this week, I began explaining that she should expect a one-time supplemental tax bill and realized very quickly that my references to Prop 13 weren’t helping at all to explain the situation. I recognized that most people, even property owners, aren’t always familiar with some of the major aspects of Prop 13 that impact us so I decided it was worth an educational piece to get us all grounded in the basics. I called Placer County and was put in touch with James Lambeth in the Tax Assessor’s Office to help ensure that my talking points correctly reflected facts and were reflected on their website.
Note: This is a California-wide proposition and affects all residents of our state at the county level which is where we pay our property taxes if we own a home or business. I chose Placer County because they have an excellent website, I can almost always reach an informed person within a day, and I live here. Sacramento and El Dorado Counties also have this information on their websites but I have not consulted them.
Proposition 13 was a voter initiative voted in by a majority of voters in 1978 that became part of the Constitution of California and was declared constitutional by the US Supreme Court. The impetus for the ballot measure was to prevent older Californians, on fixed incomes, from losing their homes due to increased property taxes. The most important aspect of the act is to limit the property tax rate. Now there are two aspects to the tax rate: 1) the base rate when the home is purchased (or when the tax assessor reassesses for new construction or additions to property) on which to assess future tax increases; 2) the yearly tax increase.
Because of Proposition 13 (also known as Prop 13), each County in California is allowed to establish a tax basis for the property at 1% of the purchase price (or if reassessed because of additions or new construction, the new assessed value). It’s actually 1% plus a fractional amount (it could be 1.25%) when the home is purchased to include additional taxes allowed. So for simplicity of an example we’re going to just use 1%. if a home was purchased for $200,000 in 2005, the assessed rate of tax would be 1% or $2000 for the year. Now, the second part of the Prop 13 is that taxes on this property may only increase up to 2% per year. Some years, assessed property values don’t go up 2%. This 2% is significant because the normal trend of property value appreciation is 6% a year in California (that is a normal year). Some basic math and a graph can show you how the difference can be sizable over the course of time! In the example below, two successive owners will pay different rates of tax based on the purchase price of the home. Let’s say for illustration purposes, the original owner from 2005-2015 is Alex Blue and let’s say the new owner is Keesha L’Orange in 2015. Alex bought his house for $200,000 and Keesha bought that same house from Alex for approximately $360,000 because houses can go up in value more than the tax rate.
When Keesha pays taxes at the closing of escrow, the title company calculates the rate based on Alex’s rate who was the previous homeowner (noted above in blue), but the County will later assess the property value at 1% of the new sales price and the difference between the old rate and the new rate will be due by Keesha in a supplemental tax bill. If a property owner has been in there a long time, the difference can be much greater than the example. The supplemental tax bill is a one-time charge. Whereas, you’ll note that once the new owner, Keesha, starts to pay taxes, the county can’t raise taxes above 2% per year as per Prop 13!
But what happens to Alex when he moves? If he moves within the same county AND he’s over 55 years old, he’s able to move his tax basis ONE time to another home. In rarer number of cases, he can transfer to another county. Only certain counties in California have adopted reciprocal arrangements. More information about that here.
What if Keesha is Alex’s daughter or grand-daughter? Well, there’s a great provision for lineal family member to keep Alex’s tax basis if the property is transferred by sale or deed to the next generation. It’s not automatic, the new owner must apply for the exemption.
GREAT BENEFIT – The Prop 13 effects on the community and property owners has provided predictability and stability when California property values have increased dramatically at times.
ON THE DOWNSIDE – Tax revenues were effectively reduced in excess of multi-billion dollars over the course of the previous 38 year period. The limited tax basis and capped yearly increases is a disincentive to sell property and so we have less inventory and that creates higher prices for homes.
Not as well known, but equally as impactful was the advent of Mello-Roos which is a special tax assessed for public services that used to be covered by property taxes before Prop 13 cut into property tax revenues for the counties. Public services covered by the Mello-Roos special tax include: infrastructure for streets, water, sewer, electricity, building of schools and parks, establishment of police protection, firefighting units, and penitentiary facilities. Additionally, sales tax has increased from 6% (pre-1978) to upwards of 8.25% to offset decreased property tax revenues. Newer developments may have the Mello-Roos tax as special, additional tax on the owner’s property tax bill. It’s always wise to ask an agent if Mello-Roos is assessed on properties you are considering buying. In some locations, these additional taxes may be several thousand dollars but can be much less as well.
Note: I’m not an expert on the subject of taxation. This was meant to be used as a general guide for people who may not have an understanding of prop 13 and its effects specifically on supplemental taxes at the time of closing. I recommend seeking additional or more detailed information and clarification from the county in which you reside or in which you will be purchasing a home.