• First, figure out how the house legally passes to you. It may transfer through a trust, joint ownership, a transfer-on-death deed, or probate.
• Expect to revisit the property tax bill. California’s Proposition 19 rules can trigger reassessment, even when a house passes from parent to child.
• Get a date-of-death value for the property. Your tax basis will generally be tied to that value, which can make a big difference if you sell.

Will Inheriting Property Be a Boon or a Bust?

You may have known for years that you were going to inherit a property when someone died. That property might have generated income that paid for your parent’s long-term care expenses or provided income to someone who had little other resources. 

You might be excited about the prospect of being the beneficiary of that asset and its income. Or maybe you’re excited to be able to move into this house and call it your own. This might be the only way you can afford to own a home. 

Before you get too excited, there’s much to consider when inheriting a piece of real estate. The rules that applied to the person who gave you this home might not apply to you. Going into this acquisition with eyes wide open will serve you well.

How Does an Inherited House Pass to You in California?

An inherited house doesn’t always become yours the moment someone dies, no matter what the dead person said before dying. How it transfers depends on the deed, the estate plan, and how the property was owned.

This is the first thing you will have to sort out before even considering selling, refinancing, or moving in.

A home held in a living trust may pass through the trust. Property owned in joint tenancy can pass to the surviving owner. Someone might have the right to live in it for the rest of their life. The house may need to go through probate.

Be careful not to jump to the conclusion that being named in a will or trust gives you immediate control over the property. It may not. Before anyone calls a Realtor or starts making plans for the house, confirm who actually has authority to act.

What Happens to Property Taxes When You Inherit a California Home?

This might be your biggest (and nastiest) surprise. The property taxes on this property may change after you inherit it. Proposition 19 narrowed the circumstances in which children can keep a parent’s existing property tax assessment, and you’ll want to understand how it works.

Proposition 19 Changed the Parent-to-Child Rules

A lot of people still assume that if Mom paid property taxes based on a decades-old purchase price, her children will simply keep paying roughly the same amount. That is no longer a safe assumption.

California voters passed Proposition 19, which went into effect on February 16th, 2021. That changed the property tax rules for most people inheriting real estate. 

For a parent-to-child transfer to qualify for the current family home exclusion, the home needed to have been the parent’s primary residence and within a year must become the primary residence of the person who inherited it. Otherwise, the whole property gets reassessed.

The numbers matter too. For qualifying transfers from February 16, 2025, through February 15, 2027, the indexed exclusion amount is $1,044,586. If the property’s market value exceeds the parent’s taxable value plus the applicable exclusion, that portion will be reassessed and the property taxes will likely increase.

That can change the economics of keeping the house.

A home that looked inexpensive to hold based on your parent’s old tax bill may look very different after reassessment. I would want that number before deciding the property is a keeper.

Will You Owe Capital Gains Tax on an Inherited House?

You may owe capital gains tax when you eventually sell, but you generally don’t inherit the previous owner’s original purchase price as your tax basis. Your basis is usually tied to the property’s fair market value at death.

The Step-Up in Basis Matters

Suppose your mother bought a Bay Area house for $300,000, and it is worth $1.5 million when she dies.

Your basis will generally be around the $1.5 million date-of-death value, subject to the applicable tax rules. If you sell soon afterward for about $1.5 million, there may be relatively little appreciation to tax.

This is why I would not skip the date-of-death appraisal just because no one plans to sell right away. Years later, reconstructing what a house was worth on a specific date can become a more difficult project.

There is another distinction worth keeping straight. Your Proposition 19 property tax assessment and your income tax basis are not the same calculation. People understandably mix them up, but they answer different tax questions.

Do You Pay Inheritance Tax on a House in California?

California doesn’t impose an inheritance tax on the person receiving the house. Receiving the property also generally doesn’t create income tax simply because you inherited it.

That sounds like the end of the tax conversation, but it’s not.

You can still face a higher property tax bill after the transfer, and you may have capital gains when you later sell. Larger estates can also have separate federal estate tax issues.

What Happens If the Inherited House Has a Mortgage?

The mortgage doesn’t disappear when the owner dies. Before making plans for the house, find out what is owed, who is servicing the loan, and what it costs to keep the property each month. Generally speaking, a lender will not call the mortgage due and require you to pay it off if you have inherited the property. No matter what, you need to keep paying the mortgage on time. 

This is one of the more mundane parts of inheriting a house, but it can drive the decision. 

Should You Keep, Rent, or Sell an Inherited House?

There is no automatic best choice. The right answer depends on the property’s real carrying costs, its tax treatment, your other assets, and whether you would choose to own this house if you were starting from scratch.

Know your numbers

You want to calculate the actual carrying costs, which include:

• Mortgage payment
• Property taxes
• Homeowners insurance
• HOA dues
• Utilities
• Routine maintenance
• Repairs that have been deferred

A house can have $1 million of equity and still be uncomfortable to carry.

That’s easy to miss when everyone is focused on what the property is worth. If the estate takes time to settle, or siblings are still deciding what to do, somebody may be writing checks for months before there is a long-term plan.

Keeping the House

Here is the question I find most useful.

If you had inherited the same amount in cash instead, would you use it to buy this house today?

That doesn’t erase the emotional side of the decision. A family home is not just another line on a balance sheet. However, the question helps separate the house you remember from the asset you would be choosing to own now.

Look at the new property tax bill, maintenance, location, insurance, and how much of your net worth would end up concentrated in one property.

Renting the House

Renting out the house can sound attractive until you run the full numbers. If you plan to use a property manager, include that cost too. 

Start with expected rent, then subtract property taxes, insurance, management, maintenance, vacancy, and the occasional large repair. A roof, sewer line, or HVAC replacement has a way of changing an elegant spreadsheet.

Also confirm the Proposition 19 consequences before assuming renting is the obvious compromise. Most rental properties are reassessed to full market value unless other provisions have been put in place to avoid this situation.

Selling the House

Selling may be the cleanest answer when the property doesn’t fit your life, requires more cash than you want to put into it, or leaves too much of your wealth tied to one piece of California real estate.

Sometimes people worry that selling means they are giving up something emotionally important. I would separate those two ideas. You can value what a home means to your family without deciding that you need to own it indefinitely.

What If You Inherit the House With Siblings?

When siblings inherit together, the math is often easier than the family dynamics. One person may want the house, another may want cash, and a third may be open to renting it.

Do not start with who “deserves” what. Start with a credible property value and a clear picture of the costs.

If one sibling wants to buy out the others, work through the valuation, financing, taxes, and ownership transfer before agreeing on a price over dinner.

The house may be a family asset, but the buyout is still a financial transaction. Treating it that way can make the family conversation easier.

What Should You Do First After Inheriting a California House?

Before choosing what to do with the house, get control of the facts. Confirm who owns it, what it is worth, what it costs to carry, and how the transfer affects the taxes.

I would start here:

• Find the deed, trust, will, mortgage statement, insurance policy, and property tax bill.
• Confirm who currently has authority to act for the property.
• Get a reliable date-of-death valuation.
• Find out whether the property will be reassessed under Proposition 19.
• Calculate the real monthly and annual carrying costs.
• Talk through the tax consequences with your CPA.
• Review the keep, rent, and sell options in the context of the rest of your financial plan.

You don’t have to decide everything in the first few weeks. However, there is a difference between giving yourself time and putting off the financial homework. 

If you’ve inherited a home in California and are not sure whether keeping it, renting it, or selling it makes the most sense, I can help you look at the numbers and how the property fits into the rest of your financial life. Sometimes getting clear on the tradeoffs is enough to make the next step much easier.

Jessica Lanning, CFP®

Email: jessica@lanningfinancial.com
Phone: (415) 354-5699
LinkedIn: linkedin.com/in/jessicalanning
YouTube Channel: Lanning Financial on YouTube

Lanning Financial Inc. is a registered investment adviser. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Past performance is not indicative of future performance.

Even a broken clock is right twice a day

Look at predictions this way:  It’s everyone’s chance to put their hat in the ring in the game of “I told you so.”  That’s all.  Somebody is going to get bragging rights at the end.  I often tell my clients that my crystal ball is as good as theirs.  I might be more educated or more experienced or more articulate about it, but it’s really just as good as anyone else’s.   Remember, past performance is not a predictor of future results.  Just because someone’s gotten it right in the past doesn’t mean that person gets it right this time around.

There are many folks out there saying the S&P is going to be up substantially within the next two years.  Time to throw all your money into the stock market, right?  Not so fast.  The last “secular bear markets”—that is, those extended periods of time since 1906 in which the market has ultimately been down from the beginning of that period to the end—have averaged about 15 years.  We’re about 10 years into this secular bear market.  Understand that even within secular bear markets, there are years that are “up” and there are opportunities to make money.  So, yeah, the markets might be up the next two years, but that doesn’t mean we’ve entered an official “secular bull market”—that is, an extended period of time in which the markets are up.  And we won’t know that until we’re officially into it, which takes 20/20 hindsight years from now.

What almost all bear markets have in common is volatility.  You have to manage volatility.  It’s a silent killer on portfolios.  Go back to your plan.  Make adjustments according to that plan.  Do your best not to lose money and don’t be greedy.  You don’t need to capture the top of the market to meet financial planning goals at risk of a significant drop.  Balance your allocations, reduce your volatility, and even out your returns so that you ultimately meet those financial goals over time.

If you’re wondering if your taxes will go up…

Here’s a short list of what expires on January 1, 2011:

1. Personal income taxes will increase:  10% to 15%, 25% to 28%, 28% to 31%, 33% to 36%, and those in the 35% bracket move up to 39.6%.   Remember, that’s just a federal hike. State taxes get put on top of that.
    
2. The “marriage penalty” will start from the first dollar earned.
    
3. The child tax credit drops from $1,000 to $500 per child.  The dependent care and adoption tax credits are reduced.
    
4. The marriage deduction reverts to the single deduction amount.
    
5. The “death tax” returns, with the top tax rate on estates over $1 million going to 55%.
    
6. The capital gains rate increases from 15% to 20%.
    
7. The dividends tax increases from 15% to 36.9% (and another 3.5% increase in 2013 for healthcare reform).
    
8. If you make an early, non-medical withdraws from a Health Savings Account, the tax increases from 10% to 20%.
    
9. Tax benefits for education tuition and fees will not be available.  Tax credits for education will be limited.
    
10. Teachers can no longer deduct classroom expenses.
     
11. Employer-provided educational assistance stops.
     
12. Many families will no longer be able to deduct student loan interest payments.

With Medicare and Social Security in trouble, a war on terror, and an aging population, I can’t see taxes going lower. What does this mean for you?  Maybe it’s time to start looking at saving strategies that allow for tax-free growth and tax-free access.

What does this mean and why do you care?

Warning:  Remember, this is a blog.  The goal here is to present the big picture on sometimes complicated subjects. By design, I oversimplify.

First, it will likely mean higher rates.  Mortgage-backed securities have bond-like quality.  They sell with a price (what they cost) and a yield (what they earn).  The law of supply and demand drives price and yield.  Sorry to haunt you with Economics 101. If prices are high, the yield goes down (which generally drives people to sell).  If prices are low, yield is high (driving people to buy).  If the Fed stops buying those securities and there is no other buyer, prices will drop to attract those buyers, yields will go up as a result, and those yields are directly correlated to mortgage interest rates, which means—you guessed it—that interest rates on mortgages have to go up as well.  Got it?

Second, understand that just a few years ago, the Fed owned no MBSs.  None.  By March, it will own $1.5 trillion.  Trillion with a T.  This means that $1.5T is now in the marketplace.  Too much money in the marketplace can mean greater inflation (too much money chasing the same amount of goods).  Now, so far, we haven’t seen greater inflation.  It’s the Fed’s job to keep that in check.  Someone also has to pay for these purchases, meaning that the American taxpayer is likely going to have to pony up money to cover it.  That may mean higher taxes—higher income taxes, higher capital gains taxes, and the list goes on.

We can’t predict the future, but we can do our best to anticipate what might be coming around the blind curves in the road.  This might be a good time to consider refinancing into that 30-year fixed-rate loan if you haven’t already.  This might be a good time to consider a loan modification.  This might be a good time to consider retirements and education funding plans that provide a tax-free component.

As a member of the Estate Planning Team, I can work with clients to implement a tax strategy called the Deferred Sales Trust, which just got its private letter ruling from the IRS this summer.  This strategy allows owners of highly appreciated assets—real property, businesses, private stock—to sell those assets and defer the capital gains taxed owed. Those clients can then earn money on the money they owe the government and can come out ahead financially with proper planning.  Even in a down economy.

How the DST works

The process starts with a property owner transferring ownership of the property to a dedicated trust, which promises to pay the client with an “installment sales contract.”  The trust then sells the property, stock or other capital asset to the buyer. The contract promises payments to the owner or their trust and those payments can be structured to continue to future generations with additional estate planning.  The tax code does not require payment of the capital gains tax until the seller starts receiving installment payments.  The DST is not unlike a no-risk “seller carry-back” financing structure.

The Deferred Sales Trust has the ability to generate substantially more money over the long run than a direct and taxed sale. It is also superior to a direct installment sale as the concerns of a defaulting buyer are eliminated.  Check it out:  www.mydstplan.com/jlanning