Neighborhoods dealing with Prop 13 and Capital Gains

Neighborhoods

We’ve lived in a middle upper class Southbay neighborhood for 43 years.  The street has 10 homes which ends in a cul-de-sac.  Five are original Prop 13 beneficiaries.  A neighbor passed away several years ago and his wife sold their home one year later.  Two of the remaining Prop 13 beneficiaries are long-term widows.  The other three are surviving couples all in their late 70’s and early 80’s.  The other five homes have turned ownership several times, but have stayed steady for the last 5 to 10 years. 

Tax Legislation

The newer homebuyers (last 10 years) on the street by any measure (average age 45 to 55) are very successful.  Their homes have appreciated substantially over and above the $250,000 per person exemption.  They won’t move up or down because of Capital gains and a Prop 13 increase.  They have the same problems as the original Prop 13 beneficiaries.  In a sense, they are locked in more than seniors.  All 10 homes are currently locked-in because of anyone of the three pieces of legislation.

Property Tax Discrepancies

The property taxes paid by the original Prop 13 beneficiaries on the block are $12,200.  The five homes that have changed ownership provide close to $125,000 in taxes.  They need tax relief.  The homes that were purchased for $40,000 to $50,000 in 1962 are all worth over 2-million-dollars and much more.  The neighborhood is all but void of young people: and, not buyer friendly for the foreseeable future.

Our neighbor’s surviving spouse sold their home for over 2-million-dollars in 2002 and paid no Capital gains.  They paid no Capital gain because of the little known piece of legislation referred to as the ‘Double-Step-Up in basis at first death’.  It is part of the Federal Estate tax code that allows all current surviving spouses to sell all their assets (commercial property and securities) paying no Capital gains taxes at any age.

Furthermore, a $1,700 property taxpayer was replaced by one that pays over $25,000.  This could happen over and over if we encourage Seniors to sell by changing State and Federal legislation.

Tax Fairness – Allow Seniors (62-65) to sell Tax Free

Our neighbor died at age 78: the problem of tax fairness surfaces. (See illustration below)

Example:  Purchase a home worth $40,000 in 1962.  Selling price is $1,800,000 in 2006

Surviving Spouse after receiving ‘Step-Up’

Senior Couple

Selling price is $1,800,000 in 2006 after one death.

Selling price is $1,800,000 in 2006 for a couple.

Property gets a new ‘Step-Up’ to   $1,800,000. (No Capital Gain)

Estimated tax for a couple selling in a home of the same value is $350,000 to $400,000.

Tax Fairness

No Tax Fairness

Why not allow long-term surviving spouses and couples sell their homes without paying Capital gains?  Why should a tax law (Federal Estate taxes ‘Step-Up’ basis Provision) meant to tax people worth more than 2-million-dollars when they die, affect Capital gains taxes for current surviving couples, when they sell their highly appreciated home?.

Federal and State Capital gains here in California (24.3%) becomes a dis-incentive to sell, especially for the people over age 65 on fixed incomes under the benefits of Prop 13.  It’s hard to believe that those seniors are trapped in their homes, but that is the case.  The ‘Step-Up’ allows the current surviving spouse to avoid the gain that might amount to $300,000 to $500,000 and more.

Conclusion

Our recommendation would do the following:

  • Free up dead capital for retirees, possibly billions over time.
  • Increase property tax revenue over time for the State and Education
  • Possible tax relief for current property taxpayers
  • Protect seniors who desire to stay and keep current Prop 13 status and allow them to sell when they want to
  • Less dependence the State has on sales tax increases
  • Help offset the loss of revenue from recent foreclosures

Our recommendations are one way around the negative side-effects of Prop 13.


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