Key Changes to Property Inheritance in California

California's Proposition 19, approved by voters in the November 2020 election, introduces substantial changes to the property tax rules that have long governed the inheritance of real estate. These new regulations, effective as of February 16, 2021, are set to reshape how families plan for the future and handle inherited properties.

Key Changes to Property Tax Rules Under Proposition 19

Before Proposition 19, California homeowners benefitted from property tax rules established under Proposition 13 (1978). These rules allowed individuals inheriting property to maintain the same low property tax basis as their parents, even for high-value properties. Proposition 19, however, restricts these benefits, particularly for heirs who wish to keep inherited properties rather than sell them.

Here’s a breakdown of the changes:

Step-Up in Basis Remains Unchanged

One significant tax benefit remains intact: the step-up in basis. This provision affects capital gains taxes when an inherited property is sold.

For instance, if a parent purchased a home for $100,000 and it appreciates to $500,000 at the time of their death, the property’s basis is adjusted to its current market value ($500,000). If the heir sells the property for $500,000, there are no capital gains taxes to pay. Only gains exceeding the current market value at the time of inheritance would be taxed. This rule continues to provide a financial advantage for heirs selling their inherited property.

Property Tax Reassessment Rules Tightened

The most significant change under Proposition 19 affects property tax reassessment rules.

Previously, a parent could transfer any property—whether a primary residence, rental property, or a second home—to their children without triggering a reassessment, as long as the property value was under $1 million or the property was the primary residence of the parent. This allowed heirs to maintain the same low property tax rates as their parents.

Proposition 19 limits this benefit to the following:

• Only a primary residence qualifies for exclusion from reassessment.
• The child inheriting the property must also make it their primary residence within one year of inheritance.
• The exclusion applies to a maximum of $1 million in value above the assessed basis.

For example, consider a primary residence with a tax basis of $100,000 and a market value of $1.5 million. Under the new rules, the first $1 million above the assessed value is excluded from reassessment. However, the remaining $400,000 (current market value minus basis and exclusion) is added to the taxable value, increasing the property tax.

If the inherited property is not a primary residence, it will be reassessed at its full market value, significantly increasing the annual property tax liability.

Potential Impacts of Proposition 19

The changes introduced by Proposition 19 will have a profound effect on families inheriting property in California:

1. Higher Property Tax Costs Heirs who wish to retain inherited property, especially properties that have appreciated significantly in value, may face higher property taxes. For many families, this could make retaining the property financially unfeasible.
2. Increase in Property Sales Some heirs may choose to sell inherited properties rather than absorb the increased tax burden. This could lead to a rise in the number of long-held family homes being sold.
3. Challenges for Multi-Generational Properties For properties that have been in families for generations, the reassessment rules may result in heirs being unable to afford the higher taxes, forcing sales and breaking long-standing familial ties to the property.

Planning Ahead

For families in California, understanding these changes is crucial for effective estate planning. Homeowners may need to explore strategies to minimize tax implications, such as irrevocable trusts or gifting property during their lifetime. Consulting with an expert is highly recommended to navigate the complexities of Proposition 19 and its impact on family assets.

Each inheritance situation is unique, and careful planning can help mitigate potential financial challenges brought about by these new regulations.

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