When my grandparents moved to California from Taiwan in the early ’90s, they bought a home in the East Bay for just over $320,000. That home is now worth five times that amount, and it’s become my home — my husband and I are gradually renovating and planning for the long haul; one day we will inherit it.
We feel incredibly fortunate, as it’s unlikely we would be able to afford such a home on our own. Yet, as the Wall Street Journal recently reported, the math on inheriting a home is changing, with many people in similar situations to mine finding the benefits of keeping an inherited property not as great as they once were.
This is especially true in California, where a proposition that went into effect in 2021 has dramatically changed the inheritance math, with one estate attorney calling it the “worst thing to happen in inheritance law in California in decades.”
So in California and the Bay Area, what options do you have if you inherit a home, or are planning to pass property on to your children? What factors should you consider before deciding to live in the home, rent it out or sell it?
Welcome to Hella Expensive, a column that’s aimed at helping readers navigate the financial aspects of living in the Bay Area. In each column, I’ll present a topic that impacts your bank account and financi.al future: homeownership and renting, the path to retirement, and how to manage your money in this infamously expensive region. Send your financial questions and concerns to me through the survey below, or email me at kellie.hwang@sfchronicle.com.
The positives of inheriting a home — and keeping it
If your parents left you their home, it can seem like a jackpot in the expensive Bay Area. Keeping a family home can also be very meaningful, especially after the difficulty of losing a parent.
“There’s a lot of sentimental value in inheriting a home,” said San Francisco estate planning and probate attorney Elizabeth Button. “ ‘We grew up here, we don’t want to get rid of it.’ It would be like saying goodbye to a family member all over again.”
Emotional attachment is a major driver for some of Button’s clients, some of whom have even taken second jobs to afford the costs of keeping the family home, she said.
For those who choose to sell, the inherited property comes with a built-in capital-gains tax perk, experts said.
“If you are planning to sell the property, there should be minimal [capital gains] taxes since the value of the home gets ‘stepped up’ or moved up to the fair market value at the time of death, freeing the inheritor from capital gains taxes in most cases,” said Ariana Alisjahbana, lead adviser with North Berkeley Wealth Management.
The challenges
But if there’s still a mortgage on the property, or major renovations or repairs are needed, that can be a big financial burden for inheritors. In the Bay Area, “a lot of people are house rich and cash poor,” Button said, which means they don’t have a lot of extra money to put into upkeep or new loan payments.
In addition, the family home often is left to multiple siblings equally, which can lead to disagreements about what to do with the property.
“If three siblings inherit a $1.5 million house from their parents, and only one of them wants to keep it, she will have to buy out the other siblings’ share for $1 million, which reflects the high cost of housing in the Bay Area,” Alisjahbana said. “It’s often not possible to buy out the siblings’ shares, so in this situation it’s common to sell the house.”
Another reason to sell can be that the inheritors have already made a life in another city or state, and don’t plan to relocate.
“Renting the home out is an option, but not everyone is interested in becoming a landlord and managing a rental property,” Alisjahbana said.
In order to transfer or inherit a property after a loved one dies, you usually have to go to probate court. It’s a lengthy and costly process and cases can take anywhere from nine to 18 months.
For those passing down property to their children, legal experts recommend meeting with an estate planning lawyer and setting up a living trust. This can help your children bypass probate court, or at least shorten the probate process.
A home on Cherry Street in San Francisco. Proposition 19 has changed the cost of inheriting a parents’ home.
Courtesy of City Real EstateHow California’s Prop. 19 changed the math
But a living trust does not address the complexities that have arisen with California’s Proposition 19, which went into effect in 2021 and curtailed the tax benefits on property transfers between parents and children.
Prop. 19 is the latest in a series of propositions over the past four decades that have shaped and then reshaped how Californians pay property taxes.
The 1978 ballot measure Proposition 13 capped property tax increases at 1% of the full cash value of the property as assessed in 1975, and which thereafter would only be reassessed when purchased, newly constructed or during a change in ownership. Annual increases are limited to 2%. Proposition 58, which went into effect in 1986, allowed a parent to transfer a home to a child without the property’s value being reassessed. These two amendments resulted in a generous tax break for those inheriting property from their parents.
That’s especially true because of the steep appreciation in home values over the past generation in California and the Bay Area. Just in the past 23 years of data available on real estate listings site Zillow, home values in the San Francisco metro area have increased from about $290,000 to $1.1 million, or nearly four times the original value.
Alexandra Ayoub, an Oakland estate planning attorney, said Prop. 19 is “an attempt to rectify some of the fallout from Prop. 13” and to “regain some of that lost tax revenue.”
Under Prop. 19, the parents’ tax basis does not pass to the child. However, if the home is the inheritor’s primary residence for at least one year after the property transfer, they can apply for an exemption that would mean some of the property’s value would be excluded from the reassessment. Even with this exemption, inheritors are likely to see a substantial increase in annual property taxes, amounting to thousands or even tens of thousands of dollars, Button said.
For those who would use the home as a second residence, they would have to pay property taxes based on the assessed fair market value, thus would see an even steeper increase in taxes.
“The intention was to shift the tax burden from certain homeowners and increase the burden on owners of inherited properties,” Ayoub said.
“I think that Prop. 19 has really thrown a wrench into how families might plan to pass along their homes, or perhaps more so, how siblings might agree to share in the family home as an asset,” Ayoub said. “The high cost of entry into the real estate market in the Bay Area has put a ton more pressure on this issue.”
Though California doesn’t have an inheritance tax, Button said Prop. 19 has basically created one. She says Prop. 19 has made it very difficult for many people to keep inherited homes because they cannot afford the additional property taxes — and she expects this issue to become only more widespread going forward.
“Most heirs are not equipped to take on a tax bill that could potentially jump from $800 to $20,000 on the death of a parent,” she said. “It will force a lot of families out of California where before, they would have had the chance to stay.”
You’ve inherited a home. Now what?
You could find yourself in many different scenarios if you inherit your parents’ home. If you have siblings, Alisjahbana said, it can be “an emotional and delicate time to make big decisions.”
“Take time to make sure you are on the same page about the next chapter of the home you’re inheriting,” she said.
If you decide to sell, Alisjahbana suggests doing so as soon as you can.
“From a capital gains standpoint, you get a ‘step up’ on the basis of the property to the fair market value at the time of death, which means most people don’t need to worry about capital gains taxes when selling an inherited home,” she said.
If you decide to rent it out, Alisjahbana said to become familiar with local landlord and tenant rules.
“Evaluate the property’s costs … and weigh them against possible rental income,” she said. “Don’t forget to include the cost of your own time to manage the property or the cost of a property manager.”
Additionally, Button suggests talking to a CPA to help you “crunch the numbers” and sort out the tax implications.
And keep in mind, this is not a one-size-fits-all process.
“Each family’s decision will depend on a myriad of factors that will go beyond the dollars and cents of taxes,” Ayoub said. “Homes and homeownership is important to many, and often these decisions involve making hard choices. There is no cookie cutter answer here. Also, the laws change all the time. Prop. 19 might not be here for long — who knows?”
Editor’s note: This story has been updated to clarify the changes to property taxes that were introduced by…
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2023-11-11 20:22:29