A home is one of the most valuable assets you can leave to a loved one – especially here in California. Still, before you codify that in your estate plan, you want to make sure that the intended beneficiary wants it – whether to live in, rent out or sell. One concern that many people have is what kind of tax burden they’ll be leaving a loved one with a home – especially if they bought it many years ago.
Up until a few years ago, people could inherit a home in California and pay property taxes only on its original value. Further, since annual property tax increases are capped at 2% each year in the state, that meant people who inherited homes that had been in their family for many years could get more money per month in rental income than they paid in annual property taxes – particularly in expensive housing markets like ours.
The end of the “Lebowski loophole”
There was even a name for this tax advantage. It was commonly referred to as the “Lebowski loophole” because The Big Lebowski star Jeff Bridges and his siblings were making a considerable amount of money (completely legally) by renting out the Malibu home their late parents purchased in the 1950s.
Amid concerns that this “loophole” was only worsening the shortage of affordable housing in the state and that some Californians weren’t paying their fair share of property taxes, voters approved Proposition 19 in Nov. 2020. Now, whenever ownership of a property changes, whether through sale or inheritance, the value is reassessed for tax purposes.
Why what a person does with an inherited home affects their taxes
That means if the person to whom you leave your home turns around and sells it or even rents it out, they’ll need to pay taxes on its value at the time they inherited it. If these make it their primary residence within a year of inheriting it, however, they’re eligible for a $1 million exclusion from the newly assessed value. If it’s a multi-unit property (even a duplex), only the portion they occupy is eligible.
Too few people consider the potential tax implications of the inheritances they leave to loved ones and others. Many are avoidable with careful estate planning. That’s one reason why it’s crucial to have experienced legal guidance as you make these important decisions.