TaxProf Blog

Editor: Paul L. Caron, Dean
Pepperdine University School of Law

Friday, July 20, 2018

Tax Laws Are Holding Back California’s Housing Market

Bloomberg, These Tax Laws Are Holding Back California’s Housing Market:

Forty years ago last month, Californians passed Proposition 13, the property-tax limitation that helped spark a national tax revolt. It’s still popular. In a March survey by the Public Policy Institute of California, 57 percent of residents, and 65 percent of likely voters, said it had been mostly good for the state, with only 23 percent saying it had been mostly bad.

Prop 13 limited local property taxes to 1 percent of purchase price (or of the assessed value in 1975) and capped subsequent increases at 2 percent a year. It also required a two-thirds legislative majority for new state taxes and two-thirds voter approval for new local taxes.

The law enjoys continued support because it gives homeowners predictable expenses. You can’t get forced out of your home simply because it’s become valuable. You move when you’re ready.

That’s the theory, anyway.

There are, however, perverse effects, some of which have been amplified by the dramatic run-up in housing prices in the Bay Area and Southern California. Prop 13 doesn’t just allow people to keep their homes until they want to sell. It also encourages them to hang on long past the time when they would have otherwise moved on. This lock-in exacerbates California’s housing crisis. ...

To ameliorate the lock-in problem, in the 1980s California voters passed initiatives that let people over 55 take their lower assessment to a new home, as long as the new place costs no more than the old one sells for. Proposition 60, passed in 1986, applies to in-county moves, while Proposition 90, passed in 1988, allows inter-county transfers if the new county approves. Homeowners can use their old assessment on a new property only once. ...

An initiative on this November’s ballot, Proposition 5, aims to reduce the incentive to stay put. It would remove the limits on the new home’s price, let homeowners transfer their assessment every two years rather than only once, and allow them to take their old assessment anywhere in the state. Someone could sell a $500,000 house with a $200,000 assessment, buy a new home for $600,000, and have a new assessment of $300,000 — the old one plus the difference. ...

t’s a good idea, but it’s a fairly minor reform. In pricey areas, two enormous tax distortions will still encourage California homeowners to stick to the old homestead. One is the federal capital gains tax, which kicks in on any profit of $250,000 or more for an individual or $500,000 for a couple. In a state where tiny bungalows routinely go for well over $1 million, that’s not much of an exemption. “There are people in San Francisco who won’t sell until they die because of the capital gains,” says Kevane.

Even when they die, their houses may never hit the market. In the same 1986 election in which voters passed Prop 60, encouraging older owners to move, they passed a different measure with the opposite effect. Known as Prop 58, it created a new class of landed aristocrats: the descendants of people who bought their homes at low prices.

The law lets homes (and up to $1 million in other property) pass from parents to children without a step-up in assessed value. Another initiative, Prop 193, does the same for grandchildren when their parents are deceased. Together these exclusions all but guarantee that a significant portion of California homes will never go on sale. They can, however, be rented out at market prices. ...

By itself, Prop 13 is fine. Its distortions would correct themselves over time, if only because death is as sure as taxes. But it wasn’t meant to establish a perpetual privilege. A state that prides itself on its dynamism shouldn’t have tax laws that lock people in place.

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the federal capital gains tax, which kicks in on any profit of $250,000 or more for an individual or $500,000 for a couple. In a state where tiny bungalows routinely go for well over $1 million, that’s not much of an exemption.

Section 121 has not been adjusted for inflation since it was enacted 21 years ago. Real estate prices have tripled in that time. There's your problem. Lock-in harms our economy.

Posted by: AMTbuff | Jul 20, 2018 8:48:01 AM

This may also explain why millionaires don't escape California income taxes in even greater numbers. The "exit fee" for capital gains on inflated house prices and for sacrificing a property tax break, which can go to heirs, are too high.

Posted by: Woody | Jul 20, 2018 10:14:14 AM

Is “holding back” liberal speak for the price is not rising — and affordability is not dropping — fast enough?

Posted by: Anon | Jul 20, 2018 11:36:17 PM

I believe "holding bacK' means there's less development and less dynamism than there otherwise would be.

Posted by: Holding back | Jul 21, 2018 9:43:21 AM

The article could at least admit the real reason for market issues is not due to the freezing of taxes but due to politicians who cannot restrain their spending and want more and more of what you have.

Market "distortions" and "inequality" occur because California politicians outrageously raise property taxes on new homes rather than being due to Prop 13 restraining tax increases for older homeowners. If equilibrium is desired, lower property taxes for everyone.

But, if California housing isn't already bad enough because of politicians, just wait until you see what they do with no restrictions on rent controls.

Posted by: Woody | Jul 22, 2018 10:05:05 AM