Federal Stepped-Up Basis Still Applies

The good news first. Under IRC Section 1014, inherited property receives a stepped-up basis equal to its fair market value at the date of death. Your parents bought a house in Silver Lake in 1978 for $85,000. When the surviving parent dies in 2025 and that house is worth $1.8 million, your income tax basis is $1.8 million. Sell it for $1.85 million the following year and your taxable gain is $50,000 — not $1.765 million.

California is a community property state, which makes this even more valuable for married couples. When one spouse dies, both halves of community property receive a stepped-up basis, not just the decedent’s half. So if mom and dad owned the house jointly as community property, the entire $1.8 million becomes the surviving spouse’s new basis when the first spouse dies. That full step-up is unique to community property states and saves California families a significant amount of capital gains tax compared to states like New York, where only the decedent’s half steps up.

Prop 19 Changed the Property Tax Rules

Before February 2021, California’s Proposition 58 let children inherit their parents’ Prop 13 assessed value on a primary residence (no limit) and up to $1 million in other real property. That meant a child could inherit a Santa Monica bungalow with a property tax bill of $2,400 a year and keep that assessment indefinitely, even though the market value was $2 million and a reassessment would push the annual bill to $20,000+.

Prop 19 gutted that benefit. Now, the parent-child exclusion only applies if:

• The property is the parent’s primary residence
• The child makes it their own primary residence within one year of the transfer
• The property’s current market value doesn’t exceed the assessed value by more than $1 million (if it does, the excess is reassessed)

Investment properties, rental homes, vacation houses — all of them get fully reassessed to current market value when transferred from parent to child. In a city where home values have tripled or quadrupled since many properties were last assessed, that reassessment can increase the annual property tax bill by $15,000 to $30,000 or more.

The Math on a Typical LA Inheritance

Let’s say your father bought a duplex in Echo Park in 1990 for $200,000. The Prop 13 assessed value in 2025 is about $400,000 (after 35 years of 2% annual increases). The property tax bill is roughly $4,800 per year.

He dies and you inherit the duplex. Current market value: $1.6 million. Since it’s a rental property (not his primary residence), Prop 19 means full reassessment. Your new property tax bill: approximately $19,200 per year. That’s an immediate $14,400 annual increase in carrying cost.

On the income tax side, your stepped-up basis is $1.6 million. If you sell immediately for $1.6 million, you owe zero capital gains tax. If you hold and sell five years later for $1.9 million, your gain is $300,000. At combined federal and California rates for a high-income taxpayer, that’s roughly $100,000 in taxes.

The decision to sell or hold now depends heavily on the new property tax burden. Before Prop 19, the low Prop 13 assessment made holding rental properties after inheritance a no-brainer. Now it’s a genuine financial decision that requires running the numbers.

Capital Gains Tax When You Sell

California taxes capital gains as ordinary income — there’s no preferential rate at the state level. For high earners in LA, that means:

• Federal: 15% or 20% capital gains rate, plus 3.8% Net Investment Income Tax for AGI over $200,000 (single) or $250,000 (married)
• California: up to 13.3% (the highest state income tax rate in the country, applying to capital gains)

Combined top rate: roughly 37%. On a $500,000 gain above the stepped-up basis, that’s $185,000 in taxes. Getting the date-of-death appraisal right can easily save or cost you five figures. Don’t use a Zestimate as your basis — hire a licensed appraiser who understands LA’s micro-markets.

What LA Heirs Should Do Now

If a parent is still alive and owns LA property, the time to plan is before the transfer happens. An irrevocable trust funded before death may remove the property from the estate for estate tax purposes, though the basis rules become more complex (the property may not receive a stepped-up basis if transferred to certain irrevocable trusts).

If you’ve already inherited property, get the date-of-death appraisal done immediately — don’t wait until you sell. Memories of the property’s condition fade, comparable sales become harder to find, and the appraisal becomes less defensible with every month that passes.

For inherited primary residences, check whether you can meet the Prop 19 requirements: move in within a year and file the claim with the LA County Assessor. Missing the one-year deadline means permanent reassessment, and there’s no extension or appeals process for late filings.