In California, the step-up in basis resets the income tax cost of inherited assets to their fair market value on the date of the owner’s death, so an heir who sells shortly after inheriting usually owes little or no capital gains tax on the pre-death appreciation. California follows the federal rule for state income tax, and because California is a community property state, married couples get an unusually generous version: when the first spouse dies, the entire community property asset can step up, not just the deceased spouse’s half. The catch sits on the property tax side. Proposition 19 can push the annual property tax bill on an inherited home up sharply even when the income tax basis has been adjusted.
How the Step-Up Works
An asset’s basis is the figure the IRS uses to measure your taxable gain when you sell. For something you bought, basis is generally what you paid. For something you inherit, federal law sets your basis at the asset’s fair market value on the date the owner died.1Office of the Law Revision Counsel. 26 USC 1014 – Basis of Property Acquired From a Decedent
A simple example. A parent bought stock for $10,000 and it was worth $100,000 at death. The heir’s new basis is $100,000. Selling right away for that amount produces zero taxable gain. Hold it and later sell for $110,000, and only the $10,000 of post-death appreciation is taxable. Without the step-up, the heir would owe tax on the full $90,000 of lifetime appreciation.
The adjustment can run the other direction too. If the asset lost value during the owner’s lifetime, basis steps down to the lower date-of-death value, and an heir who sells at that price cannot claim a capital loss.
California’s Revenue and Taxation Code adopts the same federal rules for computing gain and loss on sales, including the step-up.2California Legislative Information. California Revenue and Taxation Code 18031 That matters because California taxes capital gains at full ordinary income rates with no preferential long-term rate, and the top marginal bracket reaches 13.3%.3Franchise Tax Board. Capital Gains and Losses An heir selling a home that appreciated $800,000 during a parent’s lifetime could face a California tax bill north of $100,000 without the step-up, on top of the federal tax. The step-up removes that exposure on pre-death appreciation.
California also imposes no state estate tax and no inheritance tax. The state repealed its estate tax for deaths occurring after January 1, 2005, and its inheritance tax was eliminated earlier.4California State Controller’s Office. California Estate Tax For most California inheritances, no state-level income or transfer tax is triggered by the inheritance itself.
The Community Property Double Step-Up
California is one of nine community property states, and that status gives married couples a significant extra break when the first spouse dies. Community property generally includes assets a couple acquires during their marriage while living in California. Assets owned before the marriage, or received as a gift or inheritance during the marriage, remain separate property.
The distinction drives the tax result. Separate property owned by the spouse who dies gets the standard step-up on that asset only, and the surviving spouse’s separate property keeps its original basis. Community property receives a full basis adjustment on both halves when either spouse dies, because federal law treats the survivor’s share of community property as if it, too, were acquired from the decedent.1Office of the Law Revision Counsel. 26 USC 1014 – Basis of Property Acquired From a Decedent The IRS confirms this treatment in its community property guidance.5Internal Revenue Service. Publication 555 (12/2024), Community Property
How that plays out in practice: a couple buys a rental as community property for $300,000. When the first spouse dies, it’s worth $1,000,000. The surviving spouse’s new basis in the whole property is $1,000,000. If the same property had been held as separate property split 50/50, only the decedent’s half would step up to $500,000. The survivor’s half would keep its $150,000 original basis, leaving a blended basis of $650,000 and $350,000 of built-in gain.
Joint Tenancy Can Cost You the Double Step-Up
This is where California couples make one of the most expensive titling mistakes in estate planning. Property held in joint tenancy, rather than as community property, only steps up on the deceased spouse’s half. The surviving spouse’s half keeps its original basis. For a couple holding a home worth $1.5 million that they purchased for $400,000, the difference between community property titling and joint tenancy titling can run to hundreds of thousands of dollars in taxable gain.
Joint tenancy is the default in many states, and deeds sometimes get recorded that way without the couple realizing the tax consequence. California property currently held in joint tenancy can be converted to community property through a written transmutation agreement or a new deed. Getting the titling right while both spouses are alive is one of the highest-value moves in a California estate plan.
Documenting the Status
The double step-up only works if the asset actually qualifies as community property. Real estate requires a deed that reflects community property ownership. For financial accounts, a written community property agreement signed by both spouses can establish the character of the assets. Without clear documentation, a surviving spouse may need to litigate the question or accept a lower basis.
Assets That Do Not Get a Step-Up
Not everything resets at death. Some inherited assets stay on the decedent’s original tax footing because they represent income that was never taxed.
Traditional IRAs and employer retirement plans such as 401(k)s are the most common example. Contributions were either deductible or pre-tax, so the money inside has never been taxed. When a beneficiary inherits one of these accounts, distributions are taxed as ordinary income, just as they would have been for the original owner. There is no basis to step up in the usual sense.
A related category is income in respect of a decedent: income the person earned but had not yet received or reported before dying. Unpaid wages, accrued bond interest, and remaining installment sale payments all fall in. Beneficiaries who collect these amounts owe ordinary income tax on them.6Office of the Law Revision Counsel. 26 USC 691 – Recipients of Income in Respect of Decedents
The practical consequence for planning is clear. Appreciated assets like real estate and stock are the best candidates to leave to heirs, because the step-up wipes out the built-in income tax. Retirement accounts and other deferred-income assets carry the tax liability through to the next generation regardless.
The One-Year Gift-Back Rule
Federal law blocks an obvious attempt to game the step-up. If someone gifts an appreciated asset to a person who dies within one year, and the asset passes back to the original donor or their spouse, the step-up is denied.1Office of the Law Revision Counsel. 26 USC 1014 – Basis of Property Acquired From a Decedent The donor’s basis in the returned property is the decedent’s adjusted basis immediately before death, which is usually the same low basis the donor started with. If the property instead passes to a different beneficiary, the step-up applies normally.
Assets Held in a Living Trust Still Qualify
Most California estate plans use a revocable living trust to avoid probate, and beneficiaries sometimes worry that trust assets forfeit the step-up. They don’t. Because the grantor keeps the power to change or revoke the trust during life, trust assets are included in the grantor’s taxable estate at death.7eCFR. 26 CFR 20.2038-1 – Revocable Transfers That inclusion is what triggers the step-up, so beneficiaries get the same basis adjustment they would have received through a will.
Irrevocable trusts are different. Once assets go into an irrevocable trust, the grantor typically gives up control, and those assets fall out of the taxable estate. Without estate inclusion, there is no step-up at the grantor’s death. One structured exception involves intentionally defective grantor trusts: the grantor retains certain tax-related powers, and a common technique allows the grantor to swap appreciated assets back into their personal estate for cash or other low-basis assets, pulling the appreciated assets into the estate so they receive a step-up.
The Property Tax Trap: Proposition 19
Here is where California’s rules diverge from the income tax picture. Even though an inherited home gets a stepped-up basis for income tax, the annual property tax bill may jump sharply. Proposition 19, approved by California voters in November 2020, eliminated the broad exclusion that previously let parents pass real estate to children without a property tax reassessment.8California State Board of Equalization. Proposition 19
Before Proposition 19, parents could transfer their primary residence plus up to $1 million in assessed value of other real property to their children with no reassessment. That is gone. Any inherited property that does not meet narrow requirements is reassessed to current market value, which in many parts of California means the property tax multiplies several times over.
What You Have to Do to Keep the Reassessment Off
To qualify for even a partial exclusion, two conditions must be met:9California State Board of Equalization. Proposition 19 Fact Sheet
- The property was the primary home of the parent or grandparent who transferred it.
- The child or grandchild makes it their own primary residence within one year of the transfer.
If the heir does not move in as a primary resident, the property is fully reassessed to current market value. There is no partial credit, no grace period beyond the one year, and no exception for renting it out temporarily. Many heirs face an immediate choice: move in, accept the higher tax bill, or sell.
The Value Cap Even When You Qualify
Even when both conditions are satisfied, the exclusion has a ceiling. The protected assessed value equals the property’s existing Proposition 13 factored base year value plus an inflation-adjusted exclusion amount. For transfers between February 16, 2025, and February 15, 2027, that exclusion amount is $1,044,586.8California State Board of Equalization. Proposition 19
If the gap between the property’s fair market value and its factored base year value exceeds that exclusion, the excess gets added to the assessed value. An example:
- Factored base year value: $200,000
- Fair market value at transfer: $1,500,000
- Difference: $1,300,000
- Amount exceeding the exclusion: $1,300,000 − $1,044,586 = $255,414
- New assessed value: $200,000 + $255,414 = $455,414
The heir’s property tax bill is then based on $455,414 rather than the full $1,500,000 market value. Still a significant jump from the parent’s original $200,000 assessed value, but much better than a full reassessment.
Filing Deadlines
To receive the exclusion, the heir must file for the homeowners’ exemption or disabled veterans’ exemption with the county assessor within one year of the transfer date. Filing late does not automatically disqualify the claim, but the exclusion is only applied going forward from the date of the late filing, not retroactively to the transfer.8California State Board of Equalization. Proposition 19 The heir must also file a separate reassessment exclusion claim (Form BOE-19-P for parent-to-child transfers) with the county assessor within three years of the transfer.9California State Board of Equalization. Proposition 19 Fact Sheet
Family Farms and Grandchildren
Proposition 19 provides a parallel exclusion for family farms, defined as real property used for cultivation, pasture, grazing, or other agricultural production. The heir does not have to live on the farm. The same value cap applies per legal parcel, and the heir must file Form BOE-19-P with the county assessor within three years of the transfer.9California State Board of Equalization. Proposition 19 Fact Sheet
The same exclusion rules apply to transfers from grandparents to grandchildren, but only if the grandchild’s parent who would have qualified as the grandparent’s child is deceased. The residency, value cap, and filing requirements match the parent-child rules.9California State Board of Equalization. Proposition 19 Fact Sheet
Putting the Income Tax and Property Tax Rules Together
The interaction between the federal step-up and Proposition 19 is where many California heirs get caught. When you inherit a home, your income tax basis resets to fair market value. Sell soon after and you owe little or no capital gains tax. Keep the property and your annual property tax bill may be reassessed to that same fair market value unless you move in and meet the Proposition 19 requirements.
For an heir who plans to keep an inherited home as a rental or second residence, the math often favors selling while the stepped-up basis shelters the gain, then reinvesting the proceeds. For an heir who plans to live in the home, the Proposition 19 exclusion can preserve most of the property tax benefit, though a property with a wide gap between the base year value and current market value will still see some increase. Every situation turns on the actual numbers, so running them against the specific property before deciding is the step that matters most.