How to Claim the California Homestead Exemption on Your Taxes
Taxes are complicated and made no less so by the constant ebb and flow of changes to the tax code at both the state and federal levels. New legislation can change existing rules or impose new ones, as well as repeal rules deemed inappropriate. It’s no wonder so many people head to their favorite CPA to get their taxes handled for them.
One such example of a change in legislation is included in California’s new Assembly Bill 1885. This bill amends part of the civil code, section 740.730, which deals with the homestead exemption. The new text is as follows:
“(a) The amount of the homestead exemption is the greater of the following:
(1) The countywide median sale price for a single-family home in the calendar year prior to the calendar year in which the judgment debtor claims the exemption, not to exceed six hundred thousand dollars ($600,000).
(2) Three hundred thousand dollars ($300,000).
(b) The amounts specified in this section shall adjust annually for inflation, beginning on January 1, 2022, based on the change in the annual California Consumer Price Index for All Urban Consumers for the prior fiscal year, published by the Department of Industrial Relations.”
This is a simplification of the existing homestead exemption, as well as an increase in the value of that exemption. But what, exactly, IS this exemption, and how can you claim it on your taxes?
What Is the Homestead Exemption?
The homestead exemption is a reduction in calculated value for your home, for tax purposes. For example, if you own a home in Los Angeles that is valued at $1,000,000, and you find that you qualify for the $300,000 homestead exemption, you can apply that to your taxes. When your property value is determined for the amount of property taxes you owe, you will use a valuation of $700,000 instead of $1,000,000.
California’s effective property tax rate is 0.73%. This means that without the exemption, your property taxes will amount to $7,200. If you use the exemption, it will instead be $5,040. While a savings of $2,160 might not seem like much next to a million-dollar home, every little bit helps, especially if you live in some of the more expensive areas of California.
The homestead exemption also helps if you’re declaring bankruptcy or facing down creditors looking to place a lien on your property. Essentially, it’s a minimum value you’re guaranteed when creditors are looking to lien, levy, or otherwise repossess your assets, including your home. It’s designed to prevent you from becoming homeless, even if every other asset is forfeited.
How to Claim a Homestead Exemption
In order to claim a homestead exemption, you’ll need to qualify first. To qualify, you need to own a home in California prior to January 1 of the tax year you’re claiming, and you need to use it as a primary residence. You cannot, for example, own a home in Los Angeles but never spend time there, but still claim the exemption.
There are two kinds of homestead exemption you may be able to claim. The first is automatic, and the second is declared.
The automatic homestead exemption applies to your taxes automatically if you own and live in your home in California. When you prepare your taxes, the exemption should be declared automatically.
The declared exemption requires you to apply for it. You will need to talk to your county’s tax assessor to apply for the exemption. This exemption is aimed specifically at people who:
- Are sued in court and lose, and are required to pay damages out of their assets.
- Are selling their current home and buying a new home within a six-month period.
Essentially, it protects a portion of your assets from forfeiture so you aren’t left homeless when you sell your existing home to buy a different home. Notably, this only applies to the home you live in; if you own several properties and want to sell a non-primary residence, its value is not protected.
In order to determine which kind of exemption you should pursue, you need to analyze your situation. Luckily, this is simple. Are you selling your home? If so, are you doing so willingly, or is it a forced sale from a judgment creditor?
If you’re forced to sell your home, the homestead exemption must be paid out before the creditor can get a penny of the sale money. In this way, forced sales are less common because they’re less likely to be valuable to the creditor.
If you’re selling your home willingly, but have a judgment lien on your property, the judgment can take the money without regard for the homestead exemption, because you’ve made the decision to sell. This is how the automatic homestead exemption works.
The declared homestead exemption protects you in that second scenario by requiring the payout of the homestead exemption value prior to the judgment lien. You have a six-month period to use the homestead funds to find and invest in a new home before those funds become available to the creditors.
Unfortunately, with property values as they are in California’s urban areas, this often isn’t feasible. Even the high end of the homestead exemption value is only so much, and can’t purchase even a small single-family home in many urban centers and suburbs.
Considerations for a Homestead Exemption
The homestead exemption is not free money, and it’s not a guaranteed right to everyone who owns property in California. There are some considerations that may apply to your situation.
First of all, as mentioned above, you have to own the property and you have to consider it your primary residence. Trying to claim the exemption on a property you don’t own or on a home that is not your primary residence is a form of tax fraud and can have devastating consequences.
Secondly, the homestead exemption protects the value of your home from judgment and creditors empowered by the state. This is important because there’s one major entity that might want to recover your assets that freely ignores this protection: the IRS. The federal government, federal tax laws, federal judgments and damages, all ignore state-level regulations and laws.
The IRS has a small range of homestead credits and exemptions, but their values are comparatively low, particularly for California. Luckily, it’s exceedingly rare that the IRS pursues a forced home sale, so the chances of that protection being necessary are slim.
Next, the homestead exemption does not prevent a creditor from forcing you to sell your home to pay your debts. It merely makes it harder, and a less valuable proposition for the creditor.
If a creditor wants to force you to sell your home to pay off your debts, they will need to convince the court that it is a valuable move. They will need to prove that the sale of the home will provide enough funds to cover:
- Your homestead exemption value
- The taxes levied on the sale
- The mortgage on the home
If selling the home does not provide enough money to cover those burdens AND still put money towards paying down the debt as a liquidated asset, the judgment is unlikely to force the sale of the home.
This often protects a home from forced sale for two reasons. First, the variability of the housing market makes it uncertain what value a house will sell for when it is listed and sells. Second, the expenses of going to court to argue for the sale, as well as the entire process for enforcing judgment on the home and the resulting assets, make it a very expensive proposition. Most creditors, outside of extreme circumstances, won’t pursue a forced sale unless all other options are exhausted.
Additionally, the homestead exemption does not protect your home against foreclosure. If you use your home as collateral for a loan and cannot pay back that loan, the creditor in question can foreclose on your home, without regard for the homestead exemption. HELOC, refinancing, and other financial operations that use a home as collateral can all ignore the homestead exemption.
Essentially, the law assumes that you know what you’re doing when you use your home as collateral and that you assume that risk willingly; thus, if you fail to pay your debts and are foreclosed, it was a knowing risk you took and it’s not a protected decision.
There are also some edge cases to the exemption. For example, in one situation with a married couple, one spouse was subject to judgment and owed money, but the other did not. The homestead exemption is not by default split between both spouses; the debtor was able to claim the full amount of the exemption, rather than half. This was determined in this case.
How to Calculate Your Homestead Exemption
The California homestead exemption used to be much more complicated and much lower than it is now, thanks to the AB 1885 mentioned above. It was a confusing system that ranged from $75k to $175k and varied depending on many factors, including age.
The new exemption is flat across the board and scales according to one factor: county-wide median home prices. This is good news for people who live in expensive counties, as the median home price is high. It’s not as good for those who live in expensive areas of otherwise cheap counties, where the protected value of their home may be dragged down.
Luckily, there are both a floor and a ceiling to the calculation. At the absolute minimum, your exemption will be $300,000. This is the floor assigned in the legislation.
The ceiling, meanwhile, is double that, at $600,000. This is the cap for 2021’s California homestead exemption.
If the median value of home sales in your county exceeds $300,000 but is lower than $600,000, that value will be the value of your homestead exemption.
Additionally, every year from 2022 onwards, the law will automatically adjust for inflation. It uses the data for the annual consumer price index in California for urban consumers, which is a document published by the Department of Industrial Relations each year.
Unfortunately, there’s no specified source of the data used to determine the median home price for your county. The legislation does not specify a source, so it seems to be left up to the county tax authorities to determine what data source they use. To determine what the specific value is in your county, you may need to talk directly to your county assessor.
Should You Seek the California Homestead Exemption?
If you’re a homeowner in California, you automatically have some protection from the homestead exemption.
If you are declaring bankruptcy or have lost a lawsuit and are required to pay a judgment creditor some sum of money, the creditor may choose to seek a forced sale of your home to cover the value by liquidating the asset. If you are in this situation, the homestead exemption will protect you automatically, and there is no need to pursue applying for a special exemption.
If you are not under a forced sale of your home, and you do not intend to sell your home, you do not need to worry about the homestead exemption at all. It only really applies when you’re selling your home.
If you are under a judgment and need to pay your creditors, and you choose to sell your home without being forced to do so by those creditors, you may choose to apply for the six-month homestead exemption to declare. This will protect the exemption amount for your home sale, which guarantees you the funds to use to buy a new home. Excess funds can be subject to the creditor’s claim, however.
Overall, unless you are in a specific situation where you are not forced to sell your home, but you are selling it anyway, and you have judgments against you that require you to pay back your creditors, you don’t need to worry about the homestead exemption. The passive benefit of a lower tax burden is automatic, and the protection is unnecessary. If you’re in that situation, by all means, talk to your county assessor and apply.