Proposition 13 (Prop 13), also known as the People’s Initiative to Limit Property Taxation, was voted into California’s Constitution in 1978. It caps the amount property taxes may increase each year.
Prop 13 limits property taxes to 1% of the property’s assessed value. The property’s assessed value equals the property’s base value (the property’s value at the time of purchase), plus an inflation factor determined by California’s consumer price index (CPI). If the same owner has held the property since Prop 13 was adopted, then their home is taxed based on its assessed value in 1975.
The property’s assessed value may increase a maximum 2% each year, to compensate for annual inflation. However, it may change upon a reassessment by the county assessor. A reassessment only occurs upon transfer of title, even if the property’s actual fair market value (FMV) is substantially higher than its assessed value. [More on reassessment rules on Card 2]
On the other hand, the property’s assessed value may not be more than the current FMV. Thus, during a recessionary period of price decline, if a property’s assessed value is higher than its market value the assessed value is reduced to its reappraised value. The property is to be reappraised annually until the value exceeds its original assessed value, at which point the original assessment rules apply. [Calif. Revenue and Taxation Code §51(e)]
When a title transfer triggers reassessment, the county assessor establishes a new base value for the property due to the change in ownership. This base value is equal to the value of the property at the time of transfer and remains with the property until the next transfer. However, not all transfers trigger reassessment.
Common transactions which DO NOT trigger reassessment include:
- a transfer solely between spouses [Rev & T C §63];
- a transfer between parent(s) and child(ren) [Rev & T C §63];
- a transfer from grandparent(s) to grandchild(ren) where the parents of the grandchild are deceased [Rev & T C §63.1(a)(3)];
- a transfer between registered domestic partners [Rev & T C §62];
- the replacement of a principal residence within two years of the sale with a replacement principal residence of equal or lesser value located in the same county or an accommodating county, by a person 55 years old or older [Rev & T C §69.5];
- accommodating counties include Alameda, El Dorado, Los Angeles, Orange, Santa Clara, San Diego, San Mateo and Ventura counties, which allow the assessed value figure to be carried forward to a replacement property in their county on the sale of a principal residence in another county;
- the replacement of a principal residence by a person who is severely disabled [Rev & T C §69.5];
- a title update to properly reflect the name(s) of the person(s) holding title to the property (for example, a name change upon marriage) [Rev & T C §62];
- a change to title recorded only as a requirement for financing purposes, or to create, terminate or reconvey a security interest (e.g., cosigner) [Rev & T C §62];
- the recording of a document to substitute a trustee of a trust, mortgage or other similar document [Rev & T C §62];
- a transfer that results in the creation of a joint tenancy in which the seller (transferor) remains as one of the joint tenants [Rev & T C §65]; or
- a transfer that returns the property to the person who created the joint tenancy (original transferor). [Rev & TC §65]
Further, the transfer of a co-owner’s interest on their death does not trigger reassessment when the deceased co-owner’s interest is transferred to the surviving co-owner, if:
- the transfer is between two individuals who together own 100% of the property;
- the transfer of interest gives the surviving co-owner a 100% ownership interest in the property (thereby terminating the co-ownership); and
- the co-owners have been co-tenants of the property, residing in it as their principal residence for at least one year preceding the transfer on the death of the co-tenant, signified by an affidavit signed by the surviving co-owner. [Rev & TC §62.3(a)]
A common transfer which DOES trigger reassessment is a transfer between siblings. Transfers of partial interests held by one person also may trigger reassessment.
Prop 13 insulates homeowners who are older, retired and living on fixed incomes from payment shock when property values increase dramatically in a short period of time. Thus, Prop 13 allows them to remain in their home throughout their retirement, as they can plan for predictable annual property tax increases. Otherwise, in a market where home prices (and assessed values) are escalating quickly, they may be unable to pay their taxes.
Proponents also claim fixed annual property tax adjustments fuel the housing industry, as they give potential homebuyers an incentive (one among many homeownership subsidies) to invest in homeownership. Further, Prop 13 promotes neighborhood stability since the longer a homeowner stays in their home, the more tax savings they experience during periods when asset inflation exceeds consumer inflation.
However, long stints in a single home reduce homeowner turnover, not a favorable situation for maintaining sales volume and prices. Also negatively affected are renters, as the misplaced tax burden indirectly interferes with their opportunity to become homeowners. [More on the negative aspects of Prop 13 on Card 4]
Prop 13 is a regressive tax by any standard. This means wealthy property owners benefit from Prop 13 disproportionately. In application, property taxes place the greatest tax burden on new homebuyers and current renters, those typically least financially able to bear it.
Renters pay market rent, while their landlords’ property taxes — and thus operating expenses — are held down by Prop 13 to increase the spread of their margin of net income. Further, renters pay their landlords more of their household income to cover housing costs than homeowners pay on their mortgages and property carrying costs. Homeowners spend an average of 36% on housing costs (one-quarter less than renters).
On average, renters spend 48% of their household income on housing costs, as of 2012. This rent expenditure hinders them from saving for a down payment on their first home. This trend causes future homebuyers to put off homeownership — not good for sales volume and California’s housing market.
New homebuyers also miss out on the best tax breaks Prop 13 offers. Their property tax bills are based on today’s assessed value of their home, whereas their neighbor’s home may still be assessed at its pre-Millennium Boom value. Thus, their tax bill is likely more than twice the amount of their neighbor’s, an inequality in taxation that inhibits home acquisition.
Supporters of Prop 13 may say this is the neighbor homeowner’s right; they’ve resided in their home for over a decade and they deserve to pay a lower property tax rate. However, this government subsidy of long-established homeownership harms the local economy due to the lost tax revenue needed to provide services demanded by all homeowners.
New homebuyers – typically young families with less wealth – pay a larger share of the revenue collected by local governments to pay for public services (that’s why Prop 13 is called the “welcome stranger” law). Property taxes are crucial to a local government’s ability to provide public services their population demands. In turn, government services (if sufficient) increase property values.
For example, living in a good school district can raise property values significantly. School district performance and home values have a symbiotic relationship:
- good schools correspond to a higher demand for homes (and higher prices) in that district; and
- higher home prices lead to higher property taxes and thus more revenue available to make schools even better.
However, Prop 13 caps property taxes after acquisition, thus placing a lowered ceiling on the quality of public services (like schools, other infrastructure and services) the local government provides its residents.
A study by the Tax Foundation finds that across the board, governments are forced to compensate for low property taxes (as with Prop 13) by instilling:
- higher income tax rates;
- higher sales taxes; and
- more business taxes.
This is evidenced in a report by the Federal Reserve Bank of San Francisco, in which California comes in an abysmal 46th (out of 51) on their tax and business costs index.
Worse, Prop 13 makes room for some major corporate and investment loopholes. Investors and businesses are allowed to reduce their property taxes to miniscule amounts. For them, reassessment is only triggered if one person or entity gains a majority ownership interest in the transferred property (or an entity such as an LLC which owns the property). Thus, as long as no one investor takes a majority stake when a commercial property is transferred, an investment group can buy property today and still pay property taxes at the old assessed value with minimal tax planning.
Thus, the benefits of Prop 13 for the few long-term property owners in the community are to the general detriment of the local government, the local economy and its housing market.
Any changes to California tax law which result in an increase in taxes (of any kind) are required to be passed by a two-thirds majority in both legislative houses. [Calif. Constitution Article XIII Sec. 3(a)]
This requirement was the subject of a 2011 lawsuit, which claimed it was an all-out revision of the constitution, superseding the limits of a mere proposition. The lawsuit was unsuccessful.
Examples of potential amendments amenable to both sides of the Prop 13 encampment include adjustments based on:
- total home equity rather than purchase price;
- homeowner income tax bracket;
- the homeowner’s ability to pay; and
- use of the property as a standard to eliminate corporate and investment loopholes.
For more information on transactions excluded from reassessment, see Brokerage Reminder: Proposition 13 – transactions excluded from reassessment
For more on how Prop 13 affects income inequality, see Prop 13 renders homeownership less attainable
For more on Prop 13’s effect on school districts and home prices, see School districts, home prices and taxes
For more on the uniqueness of California’s tax system, see California is becoming less like the rest of the nation
For the status on Assembly Bill 2372, which may redefine a transfer of ownership interest for reassessment purposes, see first tuesday’s Legislative Gossip
For more information on the corporate loopholes built into Prop 13, see: Has hell frozen over? Taxpayer group drops opposition to Prop. 13 changes