Proposition 19 dramatically changes how inheriting your parent’s home is calculated. (Yalonda M. James/SF Chronicle)
There’s no shortage of data describing how difficult it is to buy a home in California, especially in the state’s expensive metropolitan areas. Home prices remain well above the rest of the country; it can take decades to save up for a down payment; and rising mortgage rates over the past few years have kept more buyers out of the market while also locking many homeowners into their current homes, exacerbating a tight market.
When my grandparents moved to California from Taiwan in the early 1990s, they bought a house in the East Bay for a little over $320,000. That house is now worth more than five times as much, and it has become my home — something my husband and I are gradually renovating and planning for the long term; one day we will inherit it. We feel very lucky because there is no way we could have afforded a house like this on our own.
Among all the challenges of homeownership, however, there’s another one: the math of inheriting a home is changing, and many people in my situation are finding that the benefits of keeping their inherited property aren’t as great as they once were.
This is especially true in California, where a law taking effect in 2021 dramatically changes inheritance calculations, with one estate lawyer calling it “the worst thing to happen to California inheritance law in decades.”
So in California and the Bay Area, what are your options if you inherit a home, or plan to pass it on to your children? What factors should you consider before deciding to live in, rent, or sell your home?
If your parents leave their home to you, it can seem like hitting the jackpot in the expensive Bay Area. Preserving the family home also makes a lot of sense, especially after the difficult loss of a parent.
“There’s a lot of sentimental value in inheriting a home,” said Elizabeth Button, a San Francisco estate planning and probate attorney. “‘We grew up here and we don’t want to get rid of it.’ It’s like saying goodbye to your family all over again.”
Emotional attachment is a key driver for some of Barton’s clients, some of whom even take on second jobs to afford a family home, she said.
For those who choose to sell, inherited property comes with built-in capital gains tax benefits, experts say.
“If you plan to sell the property, there should be minimal (capital gains) taxes because the value of the home will ‘escalate’ or rise to its fair market value at the time of death, and in most cases the heirs will not have to pay capital gains taxes,” said Ariana Alisjahbana, principal advisor at North Berkeley Wealth Management.
But if the property still has a mortgage, or needs major renovations or repairs, this can be a huge financial burden for the heirs. In the Bay Area, “a lot of people own homes but are cash poor,” Barton said, meaning they don’t have a lot of extra money to maintain or pay for new loans.
Additionally, family homes are often divided equally between multiple siblings, which can lead to disagreements about how to deal with the property.
“If three siblings inherit a $1.5 million home from their parents and only one of them wants to keep it, she will have to buy out the other siblings’ shares for $1 million, reflecting the high cost of housing in the Bay Area,” Alisjahbana said. “It’s usually not possible to buy out a sibling’s share, so in this case, selling the house is common.”
Another reason to sell may be that the heirs have started life in another city or state and have no plans to relocate.
“Renting out your home is an option, but not everyone is interested in becoming a landlord and managing a rental property,” Alis Jabana said.
In order to transfer or inherit property after the death of a loved one, you typically must go to probate court. This is a lengthy and expensive process, with cases taking anywhere from nine to 18 months.
For those who are passing their assets on to their children, legal experts recommend meeting with an estate planning attorney and setting up a living trust. This can help your children bypass probate court, or at least shorten the probate process.
But living trusts don’t solve the complexities posed by California’s Proposition 19, which takes effect in 2021 and limits the tax benefits of property transfers between parents and children.
Proposition 19 is the latest in a series of proposals over the past four decades that have shaped and reshaped the way Californians pay property taxes.
Proposition 13, a 1978 ballot measure, capped property tax increases at 1 percent of a property’s full cash value as assessed in 1975, with subsequent reassessments only upon purchase or ownership change. Annual increases are limited to 2%. Proposition 58, which took effect in 1986, allows parents to transfer their homes to their children without reassessing the property’s value. Both amendments bring generous tax breaks to those who inherit property from their parents.
This is especially true because home prices in California and the Bay Area have appreciated dramatically over the past generation. Just in the past 25 years, the value of a typical home in the San Francisco metro area has increased from about $284,000 to $1.1 million, or nearly four times, according to data provided by real estate listing site Zillow. Zillow’s estimate of a typical home’s value is based not only on the price of recently sold homes, but also on the estimated value of all homes in a selected area, which is based on sales price trends of similar homes in the area.
Oakland estate planning attorney Alexandra Ayoub said Prop. 19 “attempts to correct some of the effects of Prop. 13” and “recover some of the lost tax revenue.”
Under Proposition 19, a parent’s tax basis is not passed on to the child. However, if the home was the parent’s primary residence before their death and the children make it their permanent family residence within one year of the property transfer, they can apply to exclude up to $1 million of the value from the reassessment. Even if that limitation is excluded, heirs’ annual estate taxes could increase significantly, to the tune of thousands or even tens of thousands of dollars, Barton said.
For those who use their home as a second residence, they must pay property taxes based on the assessed fair market value, so the tax increase will be even greater.
“The purpose is to shift the tax burden on certain homeowners and increase the burden on inherited property owners,” Ayoub said.
“I think Proposition 19 does have an impact on how families plan to inherit their home, or more importantly, how siblings agree to share the family home as an asset,” Ayoub said. “The high cost of entering the Bay Area real estate market puts even more pressure on the issue.”
Patton said that although California does not have an estate tax, Proposition 19 has essentially created one. She said Proposition 19 made it difficult for many people to keep inherited homes because they couldn’t afford the additional property taxes — a problem she expects will only become more common in the future.
“Most heirs cannot afford a tax bill that can jump from $800 to $20,000 after a parent dies,” she said. “This will force many families out of California who previously had the opportunity to stay.”
If you inherit your parents’ home, you may find yourself in a number of different situations. If you have siblings, this can be an “emotional and delicate time to make big decisions,” says Alis Jabana.
“Take the time to make sure you’re both on the same page about the next chapter of the house you’re inheriting,” she says.
If you decide to sell, Alisjahbana recommends selling as soon as possible.
“From a capital gains perspective, on the basis of the property you can ‘step up’ to the fair market value at death, which means most people don’t need to worry about capital gains tax when selling an inherited home,” she said.
If you decide to rent it out, familiarize yourself with local landlord and tenant rules, Alisjahbana says.
“Evaluate the cost of the property … and weigh that against the likely rental income,” she said. “Don’t forget to include the cost of your own time to manage the property or the cost of a property manager.”
Additionally, Barton recommends talking to a CPA to help you “crunch the numbers” and address the tax implications.
Remember, this is not a one-size-fits-all process.
“Each family’s decision will depend on (many) factors, not just taxes,” Ayoub said. “Homes and homeownership are important to many people, and these decisions often involve making tough choices. There are no cookie-cutter answers here. And, the law is changing all the time. Proposition 19 may not last long — who knows?”
This is an updated version of a story originally published in 2023. Since it was first published, it has become one of the Chronicle’s most popular articles ever, and we have received many questions from readers about the impact of Proposition 19. We’ve answered some of these questions In this Q&A.
Contact Kelly Huang: kellie.hwang@sfchronicle.com.
This article was originally published on Why the calculation for inheriting a California home has changed drastically in the past few years.
