On June 6, 1978, Proposition 13 passed with a two-third majority vote, rolling back property prices to 1976 assessed values and reducing property tax rates on homes, businesses and farms by 57%. The Proposition also reduced California’s income obtained by property taxes by the same percentage. This makes Prop 13 a boon for many homeowners and a bane for California’s revenue stream.
Officially called the People’s Initiative to Limit Property Taxation, Prop 13 changed how property taxes were determined. Previous to Proposition 13, property was assessed annually to determine it’s current market value. This practice resulted in property taxes often dramatically increasing from one year to the next, especially when the real estate market was flourishing. Prop 13 replaced the yearly market valuation determination to one based on what the property sold for at the time of purchase.
According to a November 2016 Trulia article that used a combination of public tax records, census data and Trulia’s own housing value estimates, they calculated that California homeowners saved a whopping $12.5 billion in 2015 alone thanks to Proposition 13.
In addition to basing property taxes on the sale price, Prop 13 put in place a maximum 2% annual increase as long as the property wasn’t sold or significantly remodeled. Effective tax rate is defined as the total property tax a homeowner pays relative to the current market value of their residence. The same Trulia article discovered that over 40% of those owning property in California have an effective tax rate of below 0.5%, or half the 1% obligatory rate put in place by Proposition 13. This means that, the longer a homeowner remains in their residence, the more their effective tax rate drops.
Proposition 13 is an enormous incentive for homeowners to remain in a home long-term. For example, if a couple purchased a home for $500,000, they will only pay 1%, or $5,000, in annual property taxes thanks to Prop 13’s 1% property-tax cap. If the home increases in market value by 10% the next year, Prop 13 limits that increase to just 2%. So, rather than the property being taxed at $550,000, it is instead taxed at a value of $510,000, or $5,100 due in property taxes. Extrapolate this over 15, 20 or more years, and you get an idea of why effective tax rates are as low as they are for over 40% of Californians.
For homeowners, Prop 13 was a godsend. It enabled them to estimate how much they would owe each year in property taxes instead of bracing themselves for what could fluctuate wildly year-to-year, especially in affluent areas along the California coast where many older homeowners could potentially get priced out of their homes as a result of unexpected tax increases.
The Trulia article determined that long-term residents in prosperous areas are receiving the most significant benefit from Proposition 13. This occurs as a result of home prices increasing in affluent areas like the Silicon Valley, reducing effective property taxes for those who purchased their home at an appreciably lower price years before.
The Trulia article also revealed that homeowners in cities such as Los Altos and Palo Alto, where home prices are $2 million and above, pay property taxes that equate to .05% while people residing in areas where home values are dramatically less pay over twice that in property taxes.
What is causing this disproportionate taxation?
In a nutshell, regions in the state experiencing more new housing growth have more new residents and more homes assessed at a current market value and, as such, have a higher effective property tax rate. In contrast, residents who bought homes in affluent California cities years ago are not paying taxes anywhere near the current market value of their home. This means that new homeowners are taxed disproportionately higher than those who have owned and lived in their homes for years, even if those homes are technically worth more.
Despite the unbalanced taxation created by Prop 13, the chances of it being altered or revoked are extremely unlikely. Called the “third rail” in reference to its near immunity in the California political arena, making any modifications to the amendment – or even the mere suggestion of doing so – is politically unpopular.
As such, long-term homeowners will continue to reap the rewards of Prop 13 while newer homeowners will end up paying a higher effective tax rate. The revenue our state relies upon to fund infrastructure, schools and services will not get a boost anytime soon from property taxes.
Click here to read the Trulia article mentioned above.
We will be writing another article about Proposition 60/90 next month so stay tuned!
Contact Dawn Thomas today if you are thinking of selling your Silicon Valley and Santa Cruz County home.