Capital Gains on Inherited Property in California: Stepped-Up Basis

If you inherited a California house your parents bought decades ago, the capital gains question usually sounds scary. They paid $85,000, it’s worth $950,000 now, so is the IRS going to tax you on $865,000? Almost never. Inherited property gets a new cost basis, and getting that basis right (and documenting it) is the single biggest tax lever you have when you sell. This guide goes deeper than the basics: how the number is set, how California’s community property rules can double it, what you can add to it, and a few worked examples so you can see the math.

What “Stepped-Up Basis” Actually Means

Your basis is the starting number the IRS subtracts from your sale price to figure your gain. For a house you buy, it’s roughly what you paid plus improvements. For a house you inherit, IRS Publication 551 says your basis is generally the fair market value on the date of the owner’s death. Everything the house gained while your parents owned it simply drops out of the calculation.

Two more rules work in your favor. Inherited property is automatically treated as held long-term, so even if you sell three months after the funeral you get long-term capital gains treatment at the federal level. And if the house sells for less than its date-of-death value after costs, you may have a loss rather than a gain.

California’s Community Property Advantage

This is where California owners often get a better result than people in most other states. When a married couple holds a home as community property and one spouse dies, the IRS treats the entire property, including the surviving spouse’s half, as getting a new basis at the first death. In most non-community-property states, only the deceased spouse’s half steps up.

Then, when the surviving spouse later dies, the house steps up again for the children. So a couple who bought in 1979 can effectively wipe out decades of appreciation twice. The catch is how title was held. “Community property” or “community property with right of survivorship” on the deed, or a trust that clearly treats the home as community property, supports the full step-up. Plain joint tenancy can muddy it. If a parent died years ago and nobody dealt with it, pull the recorded deed and the trust before assuming either way, and if the home was supposed to be in a trust but never got deeded into it, you may first need a Heggstad petition to confirm it as trust property.

Pinning Down the Date-of-Death Value

Your basis is only as solid as the paperwork behind it. If the IRS questions your return years later, “Zillow said about $900,000” won’t hold up. The common ways to document it:

• A retrospective appraisal. An appraiser values the house as of the date of death, even if you order it months later. This is the cleanest option for trust and joint-tenancy situations where no court is involved.
• The probate referee’s inventory and appraisal. If the estate goes through probate, a court-appointed referee values the property. That figure is a reasonable basis number to keep in your file.
• The estate tax return. Very few estates owe federal estate tax, but if one files Form 706, the IRS expects heirs to use a basis consistent with the value reported there.

A quick sale can help too. When an arm’s-length sale happens a few months after death in a stable market, the sale price itself is strong evidence of value. That’s one reason heirs who sell within the first year rarely end up with a meaningful taxable gain.

What About the Alternate Valuation Date?

You may hear that an executor can value assets six months after death instead of on the date of death. That’s true, but it’s narrow. Under the tax code, the executor can only elect it when it lowers both the total value of the estate and the federal estate tax owed. In practice that means it only applies to estates large enough to owe estate tax, and it can’t be used just to give heirs a higher basis. For most families selling a single home, the date-of-death value is the number.

What Raises Your Basis (and Lowers Your Gain)

The stepped-up value is your starting point, not your final number. Two categories of cost can reduce the gain further:

• Improvements after the date of death. A new roof, a replaced sewer line, or new flooring you pay for before selling generally adds to basis. Routine repairs and cleaning usually don’t. Keep the invoices.
• Selling costs. Commissions, escrow and title fees, and documentary transfer tax all come off the amount realized. In Los Angeles that includes the county’s $1.10 per $1,000 transfer tax and, inside City of LA limits, another $4.50 per $1,000.

Three Worked Examples

These are simplified illustrations, not tax returns, but they show how the pieces fit together.

Example A is the most common outcome. The heirs sell within months, the price lands near the appraisal, and selling costs push the result into a loss. Whether that loss is deductible depends on whether the house was held as an investment or for personal use, which is a good question for your CPA.

Example B shows what holding does. The step-up froze the basis at $950,000, but four years of appreciation and rental depreciation (residential buildings are depreciated over 27.5 years, and only the building, not the land) built up a real gain. The house didn’t become a tax problem because it was inherited; it became one because it was held.

Example C is the California community property case. Without the full step-up, the surviving spouse’s half would carry the couple’s old purchase basis, and a sale shortly after death could have produced a six-figure gain. With it, there’s nothing to tax.

If You Move In: The Section 121 Exclusion

Some heirs decide to live in the house. If you own it and use it as your main home for at least two of the five years before a sale, the home sale exclusion can shield up to $250,000 of gain ($500,000 for a married couple filing jointly). The clock starts when you inherit. You can’t count the time your parent lived there. You can read more in our guide to the Section 121 capital gains exclusion.

Surviving spouses get extra help. IRS Publication 523 lets a surviving spouse count the late spouse’s ownership and use, and a surviving spouse who sells within two years of the death and hasn’t remarried may still claim the $500,000 joint amount. Combined with the community property step-up, that usually makes a sale nearly tax-free.

California’s Side of the Bill

California follows the federal step-up, so your state basis is generally the same number. The difference is the rate. The Franchise Tax Board is blunt about it: California has no lower rate for capital gains, and all gains are taxed as ordinary income. Federally, long-term gains get preferential rates; in California, any gain you do have is taxed at your regular state rate. That’s another reason a short hold usually wins.

Escrow will also ask about California real estate withholding (Form 593). When the house was the decedent’s principal residence and the estate sells it, or the sale produces a loss or zero gain, withholding generally doesn’t apply. Otherwise escrow may hold back 3 1/3% of the sale price as a prepayment toward state tax, which you get credit for when you file.

Keep this separate from property tax. Stepped-up basis is an income tax rule. Property tax runs under Prop 19, which usually reassesses an inherited home unless a child moves in. We cover that in why your tax bill jumps after inheriting.

Common Questions

Does the step-up apply if the house was in a living trust?
Generally yes. A revocable living trust is ignored for this purpose while the owner is alive, so the house still steps up at death. Irrevocable trusts can be different, and so can a life estate arrangement, so have those reviewed.

What if my parent gave me the house before they died?
Then it’s a gift, not an inheritance, and you generally take over your parent’s original basis. That’s often the most expensive mistake families make with a long-held California home.

Do I need an appraisal if we’re selling right away?
It’s still worth getting one, or keeping the probate referee’s valuation. It’s a small expense that protects every heir’s return.

Putting It to Work

The short version: document the date-of-death value, check how title was held, keep receipts for anything you put into the house, and remember that the step-up rewards selling sooner rather than later. A CPA can confirm the numbers for your situation in one meeting.

If you’d like a real number to compare against your appraisal, we’re happy to help. We either buy directly or bring a vetted cash buyer, and we can work with homes in probate, in a trust, or full of belongings. Call us at (424) 435-2326 or request a no-obligation offer online.