In California, the step-up in basis resets the income tax cost of most inherited assets to their fair market value on the date of the owner’s death, and community property gets a bigger benefit than in most states because both halves of the property step up when the first spouse dies. That treatment applies to state income tax as well as federal. Property tax is a separate story: Proposition 19 often reassesses an inherited home to current market value even though the income tax basis has stepped up.
How the Step-Up Works
An asset’s basis is the figure the IRS uses to measure taxable gain when you sell. For something you bought, basis is usually what you paid. For something you inherit, federal law resets basis to 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 quick example. A parent bought stock for $10,000, and it was worth $100,000 the day they died. The heir’s new basis is $100,000. Sell right away at that price and the taxable gain is zero. Sell later for $110,000 and only the $10,000 of post-death appreciation is taxed. Without the step-up, the heir would owe capital gains tax on the full $90,000 of lifetime appreciation.
The adjustment runs both ways. If an asset lost value before the owner died, the basis steps down to the lower fair market value at death, and an heir who sells at that price cannot claim a capital loss.
California Follows the Federal Rule for State Income Tax
California’s Revenue and Taxation Code adopts the federal rules on gain and loss from property sales, including the stepped-up basis for inherited assets.2California Legislative Information. California Revenue and Taxation Code 18031 When you sell inherited property, California measures your state income tax gain against the same stepped-up basis the IRS uses.
That conformity 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 Without the step-up, an heir selling a home that appreciated $800,000 during a parent’s lifetime could face a California bill north of $100,000 on top of the federal tax. The step-up wipes out that exposure on pre-death appreciation.
California also imposes no state estate tax or inheritance tax. The estate tax was repealed for deaths after January 1, 2005, and the inheritance tax was eliminated earlier.4California State Controller’s Office. California Estate Tax Most California inheritances therefore pass without any state-level income or transfer tax at all.
The Community Property Double Step-Up
California is one of nine community property states, and that status produces a distinct income tax advantage when the first spouse dies. Community property generally includes assets a couple acquires during marriage while living in California. What one spouse owned before marriage, or received as a gift or inheritance during marriage, stays separate property.
The distinction drives the tax result. Separate property owned by the spouse who dies gets the ordinary step-up, but only on that spouse’s asset. 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 in its community property guidance.5Internal Revenue Service. Publication 555 (12/2024), Community Property
Consider a rental property a couple bought as community property for $300,000. When the first spouse dies, it is worth $1,000,000. The surviving spouse’s new basis in the whole property is $1,000,000. Had the same property been held as separate property split 50/50, only the decedent’s half would step up, to $500,000, while the survivor’s half kept its $150,000 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 costliest titling mistakes in estate planning. Property held in joint tenancy, rather than as community property, only receives a step-up on the deceased spouse’s half. The survivor’s half keeps its original basis. For a couple holding a home worth $1.5 million that they bought for $400,000, the difference between community property titling and joint tenancy titling can be hundreds of thousands of dollars in taxable gain.
Joint tenancy is the default in many states, and deeds sometimes get recorded that way without a couple realizing the tax consequence. California couples can convert joint tenancy property to community property through a written transmutation agreement or a new deed. Getting the titling right before either spouse dies is one of the highest-value moves in a California estate plan.
Documenting Community Property Status
The double step-up depends on the asset genuinely qualifying as community property. Real estate needs 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 character of the property or accept a lower basis.
A professional appraisal establishes the fair market value of real estate as of the date of death. Securities are typically valued using the closing price on the relevant exchange that day. The executor or trustee obtains these valuations and passes the new basis figures on to the beneficiaries.
Assets That Do Not Get a Step-Up
Certain inherited assets are carved out of the step-up because they represent income that was never taxed to begin with.
Traditional IRAs and employer plans like 401(k)s are the most common example. Contributions were tax-deductible or made with pre-tax dollars, so the money inside has never been subject to income tax. When a beneficiary inherits these accounts, distributions are taxed as ordinary income, the same way they would have been for the original owner. There is no basis to adjust in the usual sense.
A related category is income in respect of a decedent, meaning income the deceased earned but hadn’t yet received or reported. Unpaid wages, accrued bond interest, and remaining installment sale payments fall here. Beneficiaries who collect those amounts owe ordinary income tax on them.6Office of the Law Revision Counsel. 26 USC 691 – Recipients of Income in Respect of Decedents
The planning consequence is straightforward. Highly appreciated assets like real estate and stock are the best candidates to leave to heirs, because the step-up erases the built-in tax liability. Retirement accounts and other deferred-income assets carry that tax liability through to the next generation regardless.
Assets Held in a Trust
Most California estate plans use a revocable living trust to avoid probate, and beneficiaries sometimes worry that trust ownership forfeits the step-up. It does not. Because the grantor can change or revoke the trust during their lifetime, the trust assets are included in the grantor’s taxable estate at death.7eCFR. 26 CFR 20.2038-1 – Revocable Transfers That estate inclusion is what produces the step-up. Beneficiaries get the same basis adjustment they would have received had the property passed under a will.
Irrevocable trusts work differently. Once assets are transferred into an irrevocable trust, the grantor generally gives up control, and those assets are no longer part of the grantor’s taxable estate. Without estate inclusion, there is no step-up at the grantor’s death. Intentionally defective grantor trusts are an exception, structured so the grantor retains certain tax-related powers. A common technique lets the grantor swap appreciated assets back into their personal estate in exchange for cash or other non-appreciated assets, bringing those appreciated assets back into the estate so they receive a step-up when the grantor dies.
Property Tax Reassessment Under Proposition 19
Here California’s rules diverge sharply from the income tax picture. Even with a stepped-up income tax basis, the annual property tax on an inherited home can jump dramatically. Proposition 19, approved by California voters in November 2020, eliminated the broad exclusion that had let parents pass real estate to children without triggering reassessment.8California State Board of Equalization. Proposition 19
Before Proposition 19, parents could transfer a primary residence plus up to $1 million of assessed value in other real property to children with no reassessment. The new law scrapped that. Any inherited property that does not meet narrow requirements is immediately reassessed to current market value, which in many parts of California multiplies the property tax bill several times over.
Requirements to Avoid Full Reassessment
To qualify for even a partial exclusion, two conditions must be met:9California State Board of Equalization. Proposition 19 Fact Sheet
- The property must have been the primary home of the parent or grandparent who transferred it.
- The child or grandchild must make the property their own primary residence within one year of the transfer.
If the heir does not move in and live there as a primary residence, 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. The rule forces heirs into an immediate decision: move in, accept a much higher tax bill, or sell.
The Value Exclusion Cap
Even when both conditions are met, the reassessment 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 occurring 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 the exclusion, the excess is added to the assessed value. For 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 is then based on $455,414 rather than the full $1,500,000 market value. That is still a sizable increase over the parent’s $200,000 assessed value, but far less than a complete reassessment.
Filing Deadlines
To claim 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 applied only going forward from the late filing date, not retroactively to the transfer date.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 Grandparent Transfers
Proposition 19 offers a parallel exclusion for family farms, meaning real property used for cultivation, pasture, grazing, or other agricultural production. The heir does not need to live on the farm. The same value cap applies per legal parcel, and the heir files Form BOE-19-P with the county assessor within three years.9California State Board of Equalization. Proposition 19 Fact Sheet
The same exclusion rules also apply to grandparent-to-grandchild transfers, 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 are identical to parent-child transfers.9California State Board of Equalization. Proposition 19 Fact Sheet
How the Two Rules Interact for a California Heir
The combination of the federal step-up and Proposition 19 produces a split outcome that catches many California heirs off guard. When you inherit a home, your income tax basis resets to fair market value. Sell soon after the death and you owe little or no capital gains tax. Keep the property, though, and your annual property tax bill may be reassessed to that same fair market value unless you move in and satisfy the Proposition 19 conditions.
For an heir who plans to hold an inherited home as a rental or a second residence, the math often favors selling while the stepped-up basis shelters the gain, then reinvesting the proceeds. For an heir who intends to live in the home, the Proposition 19 exclusion can preserve much of the property tax benefit, though homes with a large gap between the base year value and market value will still see some increase. Every situation turns on the specific numbers, so running the calculation with actual property values before deciding is the single most useful step an heir can take.