Tuesday, October 10, 2006

Property Tax Primer: Proposition 13

Part 1 of 3

They say you cannot avoid death or taxes, but if you have been a renter you have indeed skirted the obligation of paying the local tax collector. First time TIC home owners may want to brush up on a few items relating to this topic, such as Proposition 13, Supplemental Tax Bills, and San Francisco's property tax exemption.

Proposition 13, the "People's Initiative to Limit Property Taxation," was a ballot initiative passed in 1978 by California voters. Because of this amendment to the state constitution, residential property tax is limited to 1% of its assessed value, until the property is resold. In addition, once you purchase a property, its assessed value may only be increased by a maximum of 2% per year. (There are exceptions. For example, if you make substantial additions or renovations this 2% cap no longer holds true.)

In comparison, let's consider property taxes in New Jersey. My parents purchased a home there 30 years ago. They paid off the $50,000 mortgage and are happily approaching retirement. They have long imagined living out their golden years in their home town, near the friends and family they have enjoyed being close to for decades. The three bedroom split level was assessed at $250,000 some years back, which equaled $8,000 a year in property tax, a cost they could manage on a fixed income. Suddenly, in 2004, comes the real estate boom. Their relatively modest home was reassessed to be worth $500,000, and the town reset tax rates accordingly. They simply cannot afford to pay, so their only option is to sell. This has become an unfortunate fact of life in the Garden State.

In California, thanks to Prop 13, if you buy a home you are protected from an unexpected and gigantic property tax increase. And if you have children, they can inherit the capped taxes with the family house. Whenever I get annoyed by a particularly wacky ballot prop, I remember that without this populist mechanism we would not have Prop 13.

Even if you are not nearing retirement, it is important to consider the effects of Prop 13 on your home purchase.

In San Francisco, the assessed value of your home is the cash or market value at the time of purchase. This is something to keep in mind when negotiating your purchase price. Both buyers' and sellers' realtors prefer to keep the recorded sale price as high as possible. This allows the realtors to maximize their commission, gives the seller's agent more to crow about to prospective clients and protects against a downward trend in future comparables.

For example, when I purchased my TIC several years ago my realtor advised me to request a $15,000 seller rebate at closing, because of work that needed to be done on my unit. The seller agreed. My recorded sale price remained the same, but at closing I was credited $15,000. However, it would have been more advantageous for me to have asked for a $15,000 price reduction. The seller would not have cared one way or the other, and my assessed value would have been lowered by $15,000. As a result I would have paid about $150 less each year in taxes, and any future reappraisals would have been based on the lower value.

For more details on the history of Prop 13 and current issues related to property tax activism check out the Howard Jarvis Taxpayers Association.


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