What is step-up in basis and what happens if I inherit property from my parents? While this question frequently comes up on both the estate planning and trust administration side, specific California ballot measures and possible changes on the federal level make this a topic of particular interest today. Here’s where the law stands now:
On the federal level: When you inherit real property from your parents (or your grandparents, if their child/your parent is deceased), you are granted a “step-up in basis” on the value of the home to the current market value. In other words, if you choose to sell the property, you will only be taxed on the difference between the “date of death value” (what the house was worth at the time your parent died) and the sale price. Without the step-up in basis, you’d be paying taxes on the difference between the purchase price your parents paid and the money you received from the sale. If your parents lived in that house for fifty years, that would add up to a lot of taxes! With the step-up in basis, you could pay little to no taxes on the sale if you can quickly sell the house.
But what if you want to keep the house? Maybe you want to live in your childhood home or turn it into a rental property. While the step-up in basis will be nice down the road, property taxes are a more pressing concern. Fortunately, California’s Prop 13, passed in 1978, ties property taxes to the home’s purchase price, rather than the current market value, and sets limits on how much the government is allowed to increase the tax each year. When a child inherits a property from a parent (or a grandparent, if their child/your parent is deceased), the property continues to be to have property taxes assessed based on the parents’ assessed value; the property is not reassessed at your parents’ death.
Together, these rules create a win/win situation – if you choose to sell the house, you have a reduction in capital gains taxes, and if you decide to keep the home, you have a reduced property tax.
Of course, several California ballot measures would change the rules around property taxation if they pass, and if there is a change in administration, the federal step-up in basis may change as well. In either event, I will write another article with the updated regulations. In the meantime, you are welcome to ask me questions at firstname.lastname@example.org.