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When it comes to estate planning, taxes are often one of the biggest concerns for families—especially in California, where property values have increased significantly over time.

During Tax Week, many people are focused on what they owe today—but some of the most important tax decisions impact what your family may owe in the future.

One of the most important (and often misunderstood) concepts is how capital gains taxes apply to inherited assets. Understanding how these rules work can make a substantial difference in preserving wealth for your beneficiaries.

What Are Capital Gains Taxes?

Capital gains taxes apply when you sell an asset—such as real estate, stocks, or other investments—for more than you originally paid for it.

• The “basis” is typically what you paid for the asset
• The gain is the difference between the sale price and that basis
• That gain may be subject to federal and state taxes

In California, capital gains are taxed as ordinary income at the state level, which can significantly increase the overall tax burden.

The Step-Up in Basis: A Key Advantage for Heirs

One of the most valuable tax benefits in estate planning is the “step-up in basis.”

When someone inherits an asset, the cost basis is generally adjusted to the asset’s fair market value as of the date of the original owner’s death (or an alternate valuation date, if applicable).

Why This Matters

Let’s say a parent purchased a home for $200,000 decades ago. At the time of their passing, the home is worth $900,000.

• Original basis: $200,000
• Stepped-up basis: $900,000

If the beneficiary sells the home shortly after inheriting it for $900,000, there may be little to no capital gains tax owed.

This adjustment can result in significant tax savings for heirs.

What Happens If You Gift Property Instead?

Gifting assets during your lifetime is sometimes part of an estate plan—but it has very different tax consequences.

When you gift property:

• The recipient typically receives your original cost basis (carryover basis)
• There is no step-up in basis

Using the same example:

• Original purchase price: $200,000
• Current value at time of gift: $900,000

If the recipient later sells the property for $900,000, they may owe capital gains tax on the $700,000 increase.

This is why gifting highly appreciated assets can unintentionally create a significant tax burden.

California-Specific Considerations

While California does not have a state-level estate tax or inheritance tax, it does have:

• High state income tax rates, which apply to capital gains
• Property tax rules under Proposition 13
• Changes under Proposition 19 affecting non-spouse (such as parent-child) property transfers

For example, Proposition 19 significantly limited the ability to transfer a parent’s property tax base to children, particularly for properties that are not used as the child’s primary residence.

Trust Planning and Capital Gains

The way assets are held and transferred—particularly through trusts—can impact how and when the step-up in basis applies.

Properly structured estate plans may help:

• Preserve eligibility for a full step-up in basis
• Avoid unintended capital gains exposure
• Provide flexibility for beneficiaries when deciding whether to sell or retain assets

Not all trusts are treated the same for tax purposes, which is why careful planning is essential.

Common Misconceptions

Many families assume:

• “Gifting property now avoids taxes later”
• “All inherited assets are tax-free”
• “Trusts automatically eliminate capital gains taxes”

In reality, these issues are nuanced, and the wrong strategy can lead to unexpected tax consequences.

Planning Ahead Matters

Decisions about whether to gift assets, hold them, or transfer them at death should always be made with both estate planning goals and tax implications in mind.

For California families, thoughtful planning can:

• Reduce capital gains exposure
• Preserve property tax benefits where possible
• Maximize the value passed on to the next generation

 

 

We’re Here to Help

At Herbert Law Office, we help individuals and families navigate the intersection of estate planning and tax law with clarity and confidence.

If you have questions about how capital gains may impact your estate plan—or if you’d like to review your current plan—we’re here to help.