ESTATE TAXES, CAPITAL GAIN TAXES, AND PROPERTY TAXES IN PROBATE: HOW MUCH WILL YOU HAVE TO PAY?
If you are selling a California home in probate, you may be concerned about various taxes. There are three major tax categories that need to be addressed:
- Estate Taxes
- Capital Gain Taxes
- Property Taxes
Luckily, for most California residents, not all of the above taxes are going to apply. Keep reading to learn which types of taxes you must pay, and how much the process is going to cost you.
Starting in 2018, the federal estate tax limit became $11.2 million per individual, adjusted each year for inflation. For married individuals, it is $11.2 million for mom and an additional $11.2 million for dad. If dad dies first, the Internal Revenue Code allows mom to preserve dad’s $11.2 million so that when mom passes, the total combined estate will not have to pay any estate taxes if the amount is less than $22.4 million. This process is known as portability.
Estate taxes only affect less than 1% of the entire U.S population. The tax rate for estates with a value of over $11.2 million is 40%. For example, mom dies, and her estate has a value of $12.2 million. Her estate would be liable for 40% of the $1,000,000 over the limit amount, which would be $400,000 in estate taxes. Not many households in the United States have combined assets worth more than $22.4 million.
Very few individuals need to be concerned about estate taxes. If estate taxes are due, the personal representative is required to file Form 706, which is due nine months from the date of decedent’s death.
Capital Gain Taxes
Capital gain is involved whether the property is sold in probate or through a living trust. All beneficiaries involved will have to wrestle with capital gain. When calculating capital gain, you basically take the sale price, minus the cost basis, minus any improvements, less any applicable depreciation.
For example, mom bought a property for $300,000, 40 years ago. When she died, was worth $3 million. Her children have commissioned you to sell the property and are asking you how much they will pay the IRS due to the capital gain. There is good news under this scenario, and that good news is found under Internal Revenue Code 1014. This code allows the cost basis to be raised to the market value of the property as of mom’s date of death. Meaning that the cost basis for the children would step up to $3 million, the market value of the property when mom died. Therefore, if the house sells for $3 million, the capital gain amount would be zero! And the children do not have to pay capital gain taxes.
California Property Taxes
If you buy a house for $3 million, your property tax basis will be based on the $3 million value. Let’s go back to our former example, where mom bought the house 40 years ago for $300,000.
The property taxes she paid were based on that $300,000 purchase value. Now that mom passed and the property is worth $3 million, will the property taxes be reassessed to the current market
value of $3 million? In situations where the property is passed from parent to child (or child to parent), there is a reassessment exclusion available to avoid the increase of property taxes. This used to be almost a blanket exclusion under Proposition 58. However, the new Proposition 19 that went into effect in 2021 adds some caveats and limits to the blanket exclusions. Prop 19 also changes Parent-Child/Grandparent-Grandchild Transfer Exclusion as well.
You can read a detailed blog post on Proposition 19 here.