Inheriting a Parent's Rental or Second Home in California After Prop 19

What happens to property taxes when you inherit a parent's rental or second home in California?

It is reassessed to its market value as of the date of death. Since February 16, 2021, Proposition 19 limits the parent-to-child exclusion to the family home, meaning a home that was the parent's principal residence and becomes the child's principal residence. A rental, a beach cottage, a vacation home, or a small apartment building no longer qualifies, no matter how long the family has owned it. Before Prop 19, parents could pass up to $1 million of assessed value in other property to their children without reassessment. That exclusion is gone.

Plenty of Orange County families still plan as if the old rule applies. A parent who owns a duplex in Costa Mesa or a cottage near the water may assume the children will inherit the same low tax bill. They won't, and for long-held coastal property the jump can be dramatic.

Key takeaways

• For deaths on or after February 16, 2021, a parent's rental or second home passing to a child is generally reassessed to market value as of the date of death.
• A child moving into a former rental does not fix it. The home had to be the parent's principal residence too.
• The heirs usually receive a stepped-up income tax basis, so selling soon after inheriting often produces little taxable gain.
• Keeping the property means paying tax on today's value, which can turn a profitable rental into a break-even one.
• Families who own rentals should run the property tax and income tax numbers together, with their CPA and estate attorney, while the parent is still alive.

What did Prop 19 change for rental and second homes?

Before February 16, 2021, Proposition 58 let a parent transfer 2 categories of property to children without reassessment: the parent's principal residence of any value, and up to $1 million of assessed value of other real property, such as rentals and vacation homes. Prop 19 replaced that system. According to the State Board of Equalization's Prop 19 page, the intergenerational exclusion now applies to a family home and to family farms, and the family home must become the child's principal residence within 1 year.

For everything else, there is no exclusion. The Orange County Assessor's page on transfers among family explains how the remaining exclusion works and how to claim it.

How big is the property tax increase?

Here's a worked example with round numbers. A parent bought a Costa Mesa duplex decades ago. Its taxable value today is $350,000. Its market value at the parent's death is $2,000,000. Using a typical Orange County tax rate of about 1.1%:

If the duplex rents for $5,500 a month on each side, that increase eats more than 3 months of rent from 1 unit every year. On a beach cottage used only by the family, it is simply an added cost of keeping it.

The reassessment is effective as of the date of death, even if the deed records months later. That usually produces a supplemental tax bill covering the gap. Our post on Orange County property taxes explains how supplemental bills work.

Can an heir move into the rental to keep the low tax base?

No. The family home exclusion requires that the property was the parent's principal residence and becomes the child's principal residence. A child moving into a former rental meets only half of that test. The BOE's questions and answers on the intergenerational exclusion walk through the requirements.

The exclusion that does exist, for the parent's own home, has its own limits and a value cap. We cover it in can my parents transfer their house to me without a property tax increase and Prop 19 and the 1-year rule for an inherited home.

What is the good news for heirs?

Income tax. When a parent dies, inherited property generally takes a new income tax basis equal to its market value at the date of death, as IRS Publication 551 explains. For a rental the parent owned for decades, that is a big deal:

• The built-up gain disappears. If the heirs sell soon after the death at about the date-of-death value, the taxable gain is often small.
• Past depreciation stops mattering. The parent's depreciation deductions would have been recaptured if the parent had sold. With a stepped-up basis, the heirs don't inherit that recapture. Our post on selling a home you used to rent out shows how much recapture can cost a living owner.
• Heirs who keep it start depreciating again. The building portion of the new basis can be depreciated from scratch.

Our post on step-up in basis on an inherited California home covers the mechanics.

Should the heirs sell, keep, or exchange?

With several heirs, the decision is often harder than the math. Our post on inheriting a house with siblings covers buyouts and disagreements. If the family is weighing an exchange, see how a 1031 exchange works in California and the IRS overview of like-kind exchanges.

What can parents do while they're alive?

This is where planning pays off, and it needs an estate attorney and a CPA, not just a real estate agent. A few questions we encourage families to raise with their advisors:

• Does selling now make sense? Usually not for income tax reasons, because a sale during life gives up the stepped-up basis. Our post on selling now versus holding for the kids walks through that tradeoff.
• Will the rent support the new tax bill? Run the rental's numbers at the reassessed value, not today's.
• Who will manage it? If no child wants to be a landlord, a sale after death may be the family's real plan, and the documents should make that easy.
• Is the property held in an LLC or partnership? Property owned through an entity follows separate change-in-ownership rules based on who controls the entity. Don't assume an entity avoids reassessment; ask your attorney how the rules apply to your structure.

Frequently asked questions

Does Prop 19 still let parents pass a rental property to their children without reassessment?

No. For transfers on or after February 16, 2021, the parent-to-child exclusion covers only the family home and family farms. A rental or second home is reassessed to market value.

What if my parent died before February 16, 2021?

The older Proposition 58 rules generally apply to a death before that date, even if the deed records later. Confirm with the Orange County Assessor and file the correct claim form.

If I move into my parent's former rental, can I keep the low tax base?

No. The property had to be your parent's principal residence as well as yours. A former rental doesn't qualify even if you move in.

Will I owe capital gains tax if I sell an inherited rental?

Often very little. Inherited property generally receives a stepped-up basis equal to its value at the date of death, so a sale soon afterward produces little gain. Your CPA will confirm the figures.

Can I do a 1031 exchange with an inherited rental?

Heirs who hold the property for investment can generally exchange it into other investment property under the like-kind exchange rules. The replacement property will be assessed at its purchase price for property tax.

When will the higher property tax bill arrive?

The reassessment is effective as of the date of death, so expect a supplemental bill covering the period from the death to the next regular tax year, followed by regular bills at the new value.

References

• California State Board of Equalization: Proposition 19
• BOE: Prop 19 Intergenerational Transfer Exclusion, Questions and Answers
• Orange County Assessor: Transfer Property Among Family
• IRS Publication 551: Basis of Assets
• IRS: Like-Kind Exchanges, Real Estate Tax Tips

Let's look at the numbers before the next generation inherits them

We'll value the property, estimate the reassessed tax bill, and lay out the sell, keep, and exchange paths so your family and your advisors can decide with real numbers. Book a complimentary consultation or call Dar at 714-612-3870.

Dar Mardan, CPA, MBA | Vidar Group Real Estate – REAL Broker | DRE #02121982

This article is general information, not legal or tax advice. Confirm your situation with an estate attorney, your CPA, and the Orange County Assessor.