People often hear that when inheriting a home that parents have lived in for a long time, all taxes disappear. This statement is partly true and partly false. The capital gains tax on the portion that appreciated during the parents' lifetime disappears, but the portion that appreciates afterward remains.

In consultations, there is a common scenario. It involves a child inheriting a home that was purchased cheaply decades ago and planning to sell it soon. The key here is the step-up, or the adjustment of the acquisition cost.

According to Section 1014 of the federal tax code, the acquisition cost of inherited property is reset to its fair market value at the date of death. The price at which the parents originally bought it is no longer considered.

For example, if the parents bought a home for $200,000 a long time ago and it was worth $800,000 at the time of death, the child's acquisition cost becomes $800,000. The $600,000 increase in value is not subject to capital gains tax.

However, misunderstandings can arise here. If the child waits a few years after inheriting and sells the home for $900,000, the $100,000 difference is taxable. It's not that the tax has disappeared; rather, the starting point has changed.

There are also opposite cases. If the fair market value at the time of death is lower than the purchase price, the acquisition cost is adjusted down to that lower fair market value. This is referred to as a step-down.

Inherited property is treated as long-term held, regardless of the holding period. This means that even if sold a few months after inheritance, short-term tax rates do not apply.

There is one more important point for Korean families living in California. It concerns the double step-up for community property.

In most states, even if a home is jointly owned by a couple, only the deceased spouse's half is adjusted for acquisition cost. The surviving spouse's half retains the old acquisition cost.

In states like California, where community property laws exist, it's different. If the home is classified as community property, the entire acquisition cost can be adjusted to fair market value when the first spouse dies.

The issue lies in the form of ownership. A home that was registered as joint tenancy long ago may face disputes regarding its recognition as community property. You should first check how it is recorded in the title.

One situation I find particularly unfortunate is when parents transfer the home to their children during their lifetime for convenience.

Lifetime gifts do not receive a step-up. The child inherits the parents' old acquisition cost. This is referred to as carryover basis.

In the previous example, if a home bought for $200,000 is gifted and sold for $800,000, the $600,000 becomes the capital gain. This tax would not have existed if it had been inherited.

Having children listed as co-owners can lead to similar issues. The portion transferred is considered a gift, so that share may not receive a step-up.

It's also worth considering cases where the child moves into the inherited home. If they own and live in it for more than 2 years out of the last 5 years, they can exclude up to $250,000 for singles and $500,000 for married couples from capital gains.

Using both the step-up and this primary residence exclusion can often result in a significant portion of the appreciated value being settled without tax. However, the residency requirement must be proven with actual living records.

Mixing in property tax discussions can lead to confusion. The step-up pertains to capital gains tax when selling, while property tax is an annual tax paid while holding the property. They are entirely different systems.

California property tax is based on Proposition 19 (Prop 19). To inherit the old tax basis between parents and children, the child must make the home their primary residence and apply for the homeowner exemption within one year.

There is also a limit on the amount that can be inherited. According to the state Board of Equalization (BOE), from February 16, 2025, to February 15, 2027, the inherited amount can be up to the existing tax basis plus $1,044,586.

Therefore, if the inherited home is rented out or left vacant, the property tax will be reassessed based on fair market value. While capital gains tax is reduced by the step-up, property tax can significantly increase.

The federal estate tax is mostly irrelevant for most families. As of 2026, the individual exemption limit is $15 million, so a typical home does not trigger estate tax reporting.

However, it is essential to keep proof of fair market value. An appraisal dated at the time of death is necessary to prove the acquisition cost when selling later. Retrospective appraisals after several years can be costly and less reliable.

In summary, there are four key points to check: whether it's a gift or inheritance, whether the title is community property, whether a fair market appraisal was done at the date of death, and whether the property will be lived in or sold.

Tax laws can vary significantly based on individual circumstances. Be sure to consult a tax advisor or estate attorney before making any decisions.

There have been several discussions in Congress about reducing the step-up, but this regulation remains unchanged for now. It's wise to keep the possibility of future changes in mind.

In my opinion, it is generally better not to rush to transfer the home to the children's names. Organizing it through a living trust and passing it on as an inheritance has often proven to be more tax advantageous.