by Monique Runge

What taxes can be anticipated to be paid when inheriting assets in California?

Welcome to a new year with greatness ahead for new beginnings and change. What to expect in 2025 is on everyone’s mind. Our country elected a renewed President with ambitions of big change for a better place for Americans to thrive and grow.

In reflection, 2024 was a growing year economically in a few sectors. The stock market delivered returns near 25% with the top performing stocks. Orange County real estate values increased by 11.6% as of Sept 2024. Inflation continued to increase the cost of groceries, fuel/energy and insurance coverages.

Recently I spoke to Corrine with San Clemente Wealth Management plus Jennifer with Ocean Estate Law PC, both established local trusted advisors. I asked about what they are experiencing in business. Both are extremely busy assisting families with asset management and inherited wealth. Results of the ‘Great Wealth Transfer’ I have spoken of in 2024.

This takes us to understanding how Capital Gains works in California. A prominent subject for the beneficiaries of inherited wealth seeking to minimize their tax basis.

Capital gains tax is a levy imposed on the profit realized from the sale or liquidation of assets such as a home or any real estate, a business or investment portfolio of stocks, etc. In California, capital gains are taxed as regular income with no deductions, rates are between 1-13% based upon your net income bracket. The Federal IRS capital gains tax is based upon the net income amount received after standard tax deductions based upon your filing status, rates range up to 15% based upon your income bracket plus the duration of asset ownership. A layered complex calculation which is based upon the asset type. 

Federal tax deductions currently exist between $250,000 - $500,000 depending on your tax filing status. There is legislation in Congress wanting to double the $500,000 capital gains tax exemption to $1 million for a married couple and to $500,000 for a single person but has yet to pass.

This new legislation would create a significant tax benefit for the beneficiaries and positive shift for the real estate market enabling incentives to sell. Currently median home values in Orange County are between $1.15M -$1.13M, depending on the source. Most elderly homeowners do not have any mortgage debt to offset the value of real estate. This demonstrates the amount of profitability and tax liability facing many beneficiaries daily which is well above the federal tax deduction threshold offered today. When a home is inherited, Capital Gains taxes can be substantially reduced/avoided by not having to report the sale of the home. This can be done if all the following apply:

1. Your gain from the sale of the home was less than $250,000 from the basis value.

2. You have not used the tax exclusion in the last 2 years.

3. You owned and occupied the home for at least 2 of the last 5 years.

This requires a beneficiary/trustee to move into the home as a primary residence for a minimum of 2 years and have lived in the home for at least two of the five years preceding the sale of the home. Often relocation and substantial change for most families isn’t convenient or realistic due to geography. But if done properly, substantial taxes are saved. Otherwise, a 1031 exchange can be considered which requires the proceeds from the sale to be invested in a new real estate purchase within a limited time from the sale date, keeping title/ownership in the estate/trust.

When inheriting investment assets such as a retirement account, annuity or other cash valued investments, it is best to roll them over into your portfolio or create a new account to avoid paying taxes on a withdrawal. Since you are not liquidating the assets and simply keeping them invested, no income is received. However, some of these accounts can require monthly or annual distributions which will become taxable income. It is important to understand the nature of each investment asset, the terms and how it can benefit your financial future.

The subject of capital gains, income taxes and loopholes can be complex and vary depending on the uniqueness of the estate and its assets. I always encourage my readers to invest in trusted advisors in the areas of taxes, estates and investment planning. Be prepared and educated so when the day arrives, a comprehensive plan has been put in place. Employing these three trusted advisors will help ensure that you are making the most tax efficient decisions in the best interest of the estate and the beneficiaries.