Wealth transfer laws are a striking example of how something seemingly unrelated to the larger financial world can have a profound effect on complicated markets like the real estate market.
Let’s explore how wealth transfer laws in California, combined with emerging demographic shifts, can provide you with the insight you need to make key financial decisions in the real estate market.
What Is Wealth Transfer?
Wealth transfer describes the process and means by which one’s wealth is managed and distributed upon their death. Estate planning is the process through which wealth transfers are conducted. Individuals state in their will or other estate planning documents to whom their assets will go and how much.
Properly managing one’s estate is of the utmost importance; everything from savings to financial assets like bonds, stocks, and real estate holdings must be allocated to their inheritors.
Over time, laws concerning wealth transfers have adapted to modern times. Archaic estate laws created scenarios wherein wealth transfers grandfather inordinately low tax rates on inherited property. As a result, estate planning loopholes can have disruptive effects on the proper function of the real estate market.
What Are Wealth Transfer Laws in California?
California is a state at the forefront of the mission to update wealth transfer laws to reflect modern times. Real estate has been particularly affected by recent legislation to close loopholes in wealth transfer laws. Closing these loopholes creates a fairer market environment with decreased susceptibility to manipulation.
Understanding how wealth transfer laws have evolved gives you a better idea of how these developments affect the real estate market. With new legislation on the horizon, making drastic changes to old standards, California real estate is in for a significant change that could open up compelling investment opportunities.
Here’s what you need to know about California wealth transfer laws.
Proposition 13, passed in 1978, gives a massive tax advantage to inheritors of California real estate. This law stipulates how the County Assessor’s Office is able to reappraise a property’s value. An appraisal of the property value can only occur incrementally over a number of years, not all at once.
That means that a California house appraised at $100,000 in 1990 cannot immediately be reappraised to its modern value upon its inheritance. Inheritors can file a parent-to-child exclusion form that allows them to continue paying the property tax rate based on the original appraisal.
Proposition 13 results in scenarios where some California property owners could be paying a fraction of a property’s tax rate when it reappraises at its current value.
Prop 13 Loopholes
This law serves a noble purpose by ensuring that homes can stay within the family; it can prevent situations where families would otherwise be priced out due to exorbitant tax hikes.
However, the loose definition of the law has created loopholes where property owners of multi-million dollar luxury homes need only pay a fraction of its value in tax because they are grandfathered into a substantially lower rate.
Named after actor Jeff Bridges, the “Lebowski loophole” spurred amendments to Prop 13 after an investigative report by the Times discovered that the actor and his siblings were paying $5,700 a year on a Malibu property they inherited from their grandparents.
Their property taxes on the multi-million dollar vacation home remained at the original rate based on its value from the 1950s. None of the siblings lived in the house, instead opting to rent it out for $15,000 a month as a vacation home.
In November 2020, the California state legislature passed Proposition 19. Among its many changes to the property tax code were amendments to Prop 13, closing loopholes like the Lebowski loophole that allowed for egregious instances of tax avoidance.
Properties passed to kin that is used as vacation or rental homes no longer qualify for tax exemption under the new law. Unless the home being passed down is to be used as a primary residence, the property’s value will be reassessed and taxed at its modern rates.
Additionally, Prop 19 establishes a principal residence exemption for properties valued at one million dollars and higher. Property owners that inherited real estate that exceeds a value of one million dollars do not need to make property tax adjustments for the first million. After the first million, they will have to pay a reassessed tax rate on the property value.
What Do These Changes Mean for Real Estate Investors?
Changes to the California property tax code make the real estate market more competitive. Under Proposition 13, multi-million dollar properties could be held by property owners that paid a bare minimum tax on the property’s value.
These multi-million dollar vacation homes and rental properties passed down through inheritance were profoundly uncompetitive. When property owners could avoid tens of thousands of taxes, these high value homes were likely to sit there and artificially stagnate the luxury property market.
Proposition 19 reinstates fairness in the high-value real estate market. Its precise language ensures that middle and low-income homes retain their exemption benefits of Prop 13’s original vision.
High-value properties are now obligated to pay their fair share of taxes and account for operating expenses that reflect the reality of the market.
California Wealth Transfer Laws Will Create a Better High-Value Real Estate Market
Property owners will think twice about holding a multi-million dollar vacation home or rental property now that they are open to reappraisal. In all likelihood, now that the tax code accurately reflects the true costs of maintaining an additional property worth more than a million dollars, it may make owners reconsider.
High-value homes are likely to be put on the market at increasingly higher rates, creating a more competitive environment and healthier conditions for the economy overall.
With more supply in the market, premium real estate will become more balanced, more stable, and more accessible to investors. Here’s our strategy for finding the right time to acquire high-value real estate.
Proposition 19 only came into effect between February and April of 2021; its effects are only just beginning to alter market trends. However, looming demographic changes predicted by economists could have a transformational impact on the California real estate market due to the recent changes made by Prop 19.
What Is the Great Wealth Transfer?
The Great Wealth Transfer is a term coined by financial journalists and economists to describe a massive wealth transfer phenomenon that may take place over the next two decades on a macroscopic scale.
Once the largest generation in human history, the Baby Boomers hold an estimated total of 34 trillion dollars in cumulative wealth. Their children will inherit the largest generational wealth transfer of all time.
The impact of this gradual economic shift is vast; real estate, in particular, is likely to be affected by the coming wealth transfer.
How Will the Great Wealth Transfer Affect Real Estate?
Demographic trends indicate that real estate could become increasingly competitive as the Great Wealth Transfer progresses. Millennials, those born between 1981 and 1996, are the biggest age demographic of all time.
They are the generation expected to receive the majority of the Boomer wealth transfer.
Identifying prevailing trends among Millennials could give better insight as to how they could react during the Great Wealth Transfer.
Here are some key Millennial trends that could influence real estate market performance as the transfer unfolds over the next couple of decades:
- Millennials are less likely to invest in the stock market than in previous generations.
- 35 percent of Millennials aged 20-35 live at home with their parents.
- Millennials gravitate toward big cities
Millennial Trends Could Create a Stronger Real Estate Market in Big Cities
The real estate market is likely to grow more competitive as Millennials settle into the traditional homeownership age, especially in areas they prefer, like big cities.
Furthermore, if the Millennial reticence towards securities trading continues as the Great Wealth Transfer unfolds, that influx of wealth may settle in real estate investments instead. A substantial portion of Millennials doesn’t own property.
Their inherited wealth may reasonably be expected to manifest into first-time home purchases, fueling an even more competitive housing market.
How Will Wealth Transfer Affect the Los Angeles Real Estate Market?
Los Angeles real estate is situated to benefit greatly from increasing wealth transfers due to its strong appeal to young people and Proposition 19.
Young People and Los Angeles Real Estate
Young people move to Los Angeles in massive numbers every year. It’s the kind of big city that appeals to Millennials. The demand for housing in Los Angeles is strong.
The rental market is robust, and as more young people inherit wealth from their parents, the demand for homeownership is likely to increase.
Proposition 19 and Los Angeles Real Estate
Proposition 19, operating at full effect in Los Angeles, is likely to have a profound effect on the many million-dollar homes in Los Angeles. Prop 19 will likely encourage more homeowners to put their property on the market instead of handing it down to their children.
With more property going to market, in conjunction with increased demand, Los Angeles could experience explosive growth in the coming decades.
What LA Neighborhoods Have the Most Potential?
The Westside region of Los Angeles is world-famous because of its incomparable premium real estate. Westside neighborhoods are primed for a competitive market in the coming decades as their multi-million dollar homes start to hit the market.
Here are a few neighborhoods to keep an eye on in the coming years.
Holmby Hills is one of Los Angeles’ most wealthy neighborhoods. With its exclusive, manor-style homes, Holmby Hills epitomizes the luxury of the Westside. Some of the richest and most famous have their residences in Holmby Hills.
The prices for real estate in Holmby Hills range from one million to upwards of 100 million dollars, easily within the range of Proposition 19 exemption.
When people think of coastal living in California, they think of Malibu. Malibu is all-coast and has some of the county’s best coastlines. Malibu real estate has blue chip assets, with property values easily ranging in the tens of millions.
Its demographics place it squarely at the top of Los Angeles’ most wealthy areas. The average household income in Malibu is $270,291, and those falling within the 45-65 years are in the most wealthy age bracket, earning a median annual income of $184,000 yearly.
Tucked away amongst the hillsides sweeping down from the Santa Monica mountains, the Pacific Palisades is a haven for LA’s wealthiest residents. As a result, property here is extremely high-value, with few properties selling for less than a million dollars.
The average household income in the Pacific Palisades is a substantial $324,000 a year, with the strongest income bracket consisting of 45 to 65-year-olds.
Bel Air’s name communicates the Los Angeles pedigree; its real estate values reflect its name brand status. Bel Air residents are among the most affluent in Los Angeles county, with an annual average income of $364,000.
Like many affluent Westside neighborhoods, the 45 to 65-year-old age range represents the highest income bracket by age.
Perhaps the most famous neighborhood in all of Los Angeles, Beverly Hills 90210 remains one of investors’ most high-potential real estate markets. The multi-million dollar homes in Beverly Hills possess an enduring caché that keeps neighborhood property values stronger than ever.
The average annual income for Beverly Hills residents is just under $200,000, and just like the rest of the Westside’s affluent neighborhoods, the 45 to 65 age bracket is the wealthiest. Their median annual income is $129,000 a year.
How To Invest in Los Angeles Real Estate?
Now is the best time to get ahead of this potentially transformative era in Los Angeles. Getting into real estate as an individual can be extremely difficult. Individual property ownership can be challenging.
Premium properties in Los Angeles have high financial thresholds; down payments alone are often out of reach for solo investors. After accounting for operating expenses, a single Los Angeles property can be too much for one investor.
Property ownership is a time-consuming task. Vetting clients, managing the property, doing repairs, and, in the worst scenario, evicting tenants can be like a second job.
The best way to get connected with high-value real estate is through a firm. Firms have the capital and the capability to acquire the premium real estate assets that can help secure your portfolio’s future.
Invest With the Best
Christina has thrived over the past four decades in LA’s Westside. Our firm has stayed strong through the past half century’s most turbulent economic moments. We see the potential the future has in store; that’s why our team uses our current resources to seize new opportunities ahead of the curve.
Get started with Christina today, and reap the benefits that lie in wait tomorrow.