If you own your home free of a mortgage, that’s likely one of the most valuable single assets you have to pass down to your loved ones when you’re gone. Maybe you have your family home as well as a vacation home or rental property. These could have a combined (and even individual) value well into millions of dollars.
Here in California, there are tax implications for those who inherit properties. Therefore, it’s critical to do some careful strategizing about your home(s) when determining your estate planning preferences.
No more “Lebowski loophole”
California law has changed in recent years and so have the tax implications for those who inherit homes. The goal has been to remove some of the significant tax advantages that heirs used to have that kept them holding on to properties rather than selling them and making them available in California’s tight housing market.
Until not long ago, if someone inherited a home, they only had to pay property taxes on its assessed value when it was purchased by the deceased rather than its current value. Further, that rate couldn’t increase by more than 2% each year going forward.
Obviously, this meant people who chose to keep homes bought by loved ones decades earlier were paying nowhere near the property taxes that neighbors who just bought their home were paying. Further, they could rent the home out and make a significant profit, especially if it was in a coveted area.
This was widely referred to as the “Lebowski loophole.” That’s because the children of actor Lloyd Bridges (among them, Jeff Bridges, who starred in The Big Lebowski), did that with their late parents’ Malibu home that was purchased long before property values in the area skyrocketed. There was nothing illegal about what the Bridges did. They were just a famous example of what many families were doing up and down the state.
California voters closed the Lebowski loophole in 2020 by approving a proposition that requires a home’s property value to be reassessed not just when it’s sold but when it’s inherited. That means those who inherit it are paying property taxes in line with what it’s actually worth. There is some advantage under the law to making an inherited property a primary residence as opposed to renting it out – specifically $1 million deducted from the home’s current assessed value.
It’s always important to consider the tax and other financial implications of any significant asset you leave to a loved one before committing to a plan of action. With sound estate planning guidance, you can make the best decisions for your family within the bounds of the law.