Planning for the succession of your real estate assets is one of the most critical financial decisions you can make.
The method you choose—or don’t choose—can have significant consequences for your heirs, affecting everything from the timeline for accessing the property to the taxes they will owe.
This article explores three essential, yet technical, areas of property inheritance, focusing primarily on the laws and practices within California, specifically concerning trusts vs. probate, the step-up in basis, and the impact of Proposition 19 (Prop 19).
Disclaimer: The information provided here is for informational purposes only. It is not legal or tax advice.
Always consult with a qualified estate planning attorney or tax professional before making any decisions related to your estate.
1. Trust vs. Probate: A Clear Path to Succession
The primary decision in estate planning is whether to create a living trust or allow your estate to pass through the probate process. The distinction lies in control, organization, and timing.
Having a Trust: Creating a trust means you, as the planner, do the crucial work upfront.
You organize your assets and detail exactly how you want your estate to be managed by a successor trustee.
The most significant benefit is avoiding probate. Your heirs gain access to your assets almost immediately, bypassing the court system, which can take over a year to navigate in places like LA County.
It’s important to note that a trust is for succession planning and organization—it does not provide liability protection for multiple properties.
Without a Trust (Probate): If you pass away without a fully funded trust, your estate must go through probate.
While this process will eventually distribute your assets and allow your heirs to benefit from the step-up in basis (discussed below), it can be a lengthy, expensive, and stressful public court proceeding for those you leave behind.
2. The Step-Up in Basis: Minimizing Capital Gains Tax
When an inherited property is eventually sold by your heirs, the calculation of capital gains tax is determined by its cost basis.
This is where the “step-up” is profoundly beneficial.
Let’s look at an example:
| Scenario | Purchase Price (Original Basis) | Value at Time of Death | Sale Price by Heir | Taxable Gain |
|---|---|---|---|---|
| Old System (Joint Tenancy) | $150,000 (1995) | $1,000,000 | $1,000,000 | $850,000 |
| Trust or Probate (Step-Up) | $150,000 (1995) | $1,000,000 | $1,000,000 | $0 |
How it Works: When property is inherited via a trust or probate, the property’s cost basis “steps up” to its fair market value on the date of death.
If your heir sells the property immediately for that same market value, the difference between the new basis and the sale price is minimal or zero, resulting in little to no capital gains tax.
The Contrast: If you simply add someone as a joint tenant to your deed (often done to avoid probate), they inherit your original low cost basis.
When they sell, they could be taxed on the massive appreciation since your original purchase (e.g., $850,000 in the example above), leading to a significant tax bill.
3. Proposition 19: Impact on Property Taxes
Proposition 19, passed in California in 2021, affects the annual property taxes paid when a residential property is inherited, imposing a recurring cost that must be factored into succession planning.
The impact of Prop 19 depends entirely on who inherits the property and how they use it:
Principal Residence Exemption: A direct descendant (child or grandchild) can prevent a full property tax reassessment only if they use the inherited single-family home as their primary residence within one year of the transfer.
Even then, the exemption is limited, allowing them to keep a capped tax value up to $1 million above the current assessed value.
Investment Property: If the inherited property is a residential income property (multi-unit investment) or if the heir does not move into the single-family home, the property will be reassessed to its full current market value upon transfer.
This reassessment can cause the annual property tax bill to jump significantly.
For instance, a property with an old assessed value of $150,000 could be reassessed at $1.5 million, causing a massive increase in the tax burden.
In many cases, the dramatic property tax increase on inherited investment properties under Prop 19 may make it financially unfeasible for heirs to keep the asset, often leading to a sale.
Plan Today to Protect Your Legacy Tomorrow
Understanding these three areas is critical for effective estate planning.
While the technical jargon can be daunting, the financial repercussions of poor planning—or no planning at all—are severe for those you care about.
Whether you’re planning your own estate or are a prospective heir, take the initiative to have these serious, yet delicate, conversations.
Seek professional guidance from an estate planning attorney and a real estate specialist to ensure you have a clear plan that maximizes benefits and minimizes taxes for your legacy.