California Inheritance Tax: Essential Tips for Smart Planning

Here’s the thing nobody wants to talk about at family dinners: California inheritance tax planning feels like a burden, but it’s one of the smartest moves you can make. Whether you’re inheriting a house in San Francisco, a business in LA, or just trying to understand what you actually owe, the confusion is real. The good news? California doesn’t have a state-level inheritance tax like some states do, but that doesn’t mean you’re off the hook entirely. Federal taxes, capital gains, and estate complications can still hit hard. Let’s cut through the noise and talk about what actually matters for your wallet.

Does California Have an Inheritance Tax?

Let’s start with the relief: California does not have a state inheritance tax or estate tax. That’s a win compared to states like New Jersey, Pennsylvania, or Iowa. But before you celebrate too hard, understand that this doesn’t mean you’re completely tax-free on inherited assets. The absence of a state-level California inheritance tax is actually one of the few tax-friendly aspects of inheriting in California, but federal rules and other complications can still apply.

Think of it like this: California isn’t taking its cut, but the IRS might be. The federal government has its own rules about who pays taxes on inherited money and property, and those rules apply to everyone, regardless of where they live. For most middle-class heirs, federal taxes won’t be an issue because of the high exemption threshold (currently $13.61 million for 2024), but if you’re inheriting substantial wealth, it’s a different story.

Pro Tip: Even though California doesn’t tax inheritances directly, you still need to file federal estate tax returns if the estate exceeds the federal exemption. Ignoring this is a fast way to trigger an IRS audit.

Federal Estate Tax vs. California State Rules

Here’s where things get interesting. While California has no state estate or inheritance tax, the federal government absolutely does—but only if your inheritance is large enough. The federal estate tax exemption for 2024 is $13.61 million per person. For married couples, it’s $27.22 million combined. If the total estate is below that threshold, there’s typically no federal estate tax owed.

California’s lack of an estate tax is a huge advantage. According to the IRS official guidance on estate and gift taxes, states that impose their own estate taxes often have much lower exemption thresholds. California doesn’t play that game, which is one reason why wealthy families sometimes relocate to California before passing assets to heirs.

However, here’s the catch: the federal exemption is set to drop significantly in 2026. Unless Congress acts, it’ll fall back to roughly $7 million per person (adjusted for inflation). If you’re dealing with a substantial estate, this timeline matters. Your family might have less than two years to implement tax-reduction strategies.

The key difference is that California focuses on income tax for residents and businesses, not on the transfer of wealth through inheritance. This is a deliberate policy choice that makes California different from the East Coast states, which historically relied on estate taxes as revenue sources.

Capital Gains Tax on Inherited Property

Here’s where most people get blindsided: even though there’s no California inheritance tax on the transfer itself, you might face capital gains taxes when you sell inherited property. This is huge, and it trips up a lot of heirs.

Let’s use a real example. Your parent bought a house in 1985 for $150,000. It’s now worth $1.2 million. They pass it to you. Under federal law, you get a “step-up in basis” to the fair market value at the time of death—so your basis becomes $1.2 million, not $150,000. If you sell it immediately for $1.2 million, you owe zero capital gains tax. That’s the good part.

But if you hold the property and it appreciates to $1.3 million before you sell, you owe capital gains tax on that $100,000 gain. California has no state-level capital gains tax on long-term investments (though there’s a 3.876% net investment income tax on high earners), but the federal long-term capital gains rate is 15% or 20% depending on income level. That’s still real money.

According to Investopedia’s breakdown of step-up in basis, this rule is one of the biggest tax advantages available to heirs. It essentially allows you to reset the cost basis of inherited assets, which can save hundreds of thousands of dollars in taxes.

Warning: If you inherit property from someone who lived outside California, state income tax rules might still apply depending on where the property is located. Consult a tax professional before selling inherited real estate.

Smart Strategies to Minimize Tax Burden

Okay, so you’re inheriting something substantial. What can you actually do to reduce the tax hit? Here are the real strategies that work:

1. Understand the Step-Up in Basis: This is your biggest tax advantage. By inheriting rather than receiving a gift during someone’s lifetime, you get to reset the cost basis. Use it. If you inherit appreciated stock, real estate, or other assets, the step-up protects you from capital gains taxes on appreciation that happened before death.
2. Consider Timing on Sales: Don’t rush to sell inherited property. If you hold it for more than a year after inheriting, you qualify for long-term capital gains treatment (15% or 20% federal rate) rather than short-term rates (up to 37%). That difference is massive.
3. Split Income with a Spouse (if applicable): If you’re married and inherit together, you can split income on inherited assets in certain situations, which might lower your overall tax bracket.
4. Use Charitable Giving: If you inherit a large portfolio and have charitable interests, a charitable remainder trust or donor-advised fund can reduce your tax burden while supporting causes you care about.
5. Disclaim Unwanted Inheritances: If you inherit something that comes with tax liability you don’t want, you can disclaim it (refuse it formally) within nine months. The asset then passes to the next beneficiary. This is a legitimate tax strategy, not tax evasion.

These strategies require planning, and some require professional help. But they’re all legal and commonly used by people who take their tax situation seriously.

Understanding the Step-Up in Basis

Let’s dive deeper into the step-up in basis because this is genuinely the most powerful tax tool available to heirs, and most people don’t fully understand it.

When someone inherits property, the IRS allows the heir to use the property’s fair market value at the date of death as the new “basis” for tax purposes. This is called a step-up in basis (or step-down if the asset decreased in value, though that’s rare).

Here’s why it matters: If your parent bought Apple stock in 1990 for $1,000 and it’s worth $50,000 when they die, your new basis is $50,000. If you sell it the next day for $50,000, you owe zero capital gains tax on that $49,000 appreciation. That’s a tax-free inheritance of gains, which is extraordinary.

Compare this to a gift. If your parent gave you that same Apple stock while alive (instead of willing it to you), your basis would be $1,000. When you sell it for $50,000, you owe capital gains tax on $49,000. The difference is roughly $7,350 in federal taxes (at the 15% long-term rate), plus California taxes if applicable.

This is why wealthy families often hold appreciated assets until death rather than gifting them. It’s not morbid—it’s smart tax planning. The step-up in basis is available to all heirs, regardless of income level, which makes it one of the few tax breaks that applies equally to everyone.

However, understand that this benefit only applies to inherited assets. Inherited IRAs, 401(k)s, and other retirement accounts have different rules (more on that below). Also, if the estate is large enough to owe federal estate tax, the step-up benefit is reduced by the estate tax paid.

Planning for Inherited Retirement Accounts

Inherited retirement accounts are their own beast, and they deserve special attention. The rules changed significantly in 2020 with the SECURE Act, and many heirs are still confused about what they owe.

If you inherit a traditional IRA or 401(k), you generally have to take distributions from it. The timeline depends on your relationship to the deceased and the type of account. Spouses have the most flexibility—they can roll the account into their own IRA and delay distributions. Non-spouse heirs, however, are required to withdraw the entire balance within 10 years (as of 2023, under current rules).

Here’s the tax hit: every dollar you withdraw from an inherited traditional IRA is taxable income. If you inherit a $500,000 IRA and withdraw it all in one year, you’ll owe income tax on that entire $500,000. That could bump you into a much higher tax bracket and create a massive tax bill.

The smart move? Spread the withdrawals over the 10-year window. Instead of taking $500,000 in year one, take $50,000 per year. This keeps you in a lower tax bracket each year and reduces your overall tax burden. You can also coordinate these withdrawals with other income sources to optimize your tax situation.

Pro Tip: If you inherit a Roth IRA, the same 10-year withdrawal rule applies, but distributions are tax-free. This is one of the few silver linings with inherited retirement accounts. Prioritize spending down traditional IRAs first, and let Roth IRAs grow as long as possible.

For more details on how retirement account distributions work, check out the IRS’s official guidance on retirement account beneficiaries.

Common Mistakes Heirs Make (And How to Avoid Them)

After working through hundreds of inheritance situations, I’ve seen patterns. Here are the mistakes that cost people real money:

1. Failing to File an Estate Tax Return: Even if no tax is owed, you might need to file Form 706 (the federal estate tax return) if the estate exceeds the exemption threshold. Missing this deadline can trigger penalties and audits. The deadline is nine months after death (extendable to 15 months with proper filing).
2. Selling Inherited Property Too Quickly: Impatient heirs often sell inherited real estate within months of inheriting it. This is understandable but costly. Wait at least a year to lock in long-term capital gains treatment. Also, if you’re selling a primary residence that was the deceased’s home, you might qualify for an exclusion on capital gains—but only if you meet specific requirements.
3. Ignoring Stepped-Up Basis Benefits: Some heirs don’t realize they have a stepped-up basis and pay unnecessary capital gains taxes. Work with a tax professional to document the fair market value of inherited assets at the date of death. This becomes your basis.
4. Not Coordinating with Estate Administration: The executor of the estate and the heirs sometimes don’t communicate about tax strategy. This leads to missed deductions and inefficient planning. Get everyone on the same page early.
5. Forgetting About Income in Respect of a Decedent (IRD): If the deceased had unpaid income (like a final paycheck, deferred compensation, or accrued interest), that’s taxable to the heirs. This is called IRD, and it’s often overlooked. You can claim a deduction for estate taxes paid on IRD, but you have to know it exists to claim it.
6. Missing Deadlines for Inherited Retirement Accounts: The 10-year withdrawal window for inherited retirement accounts is strict. Missing it means penalties and excess distributions. Mark your calendar and set reminders.

Working with Professionals: When You Need Help

Let’s be real: some inheritance situations are simple enough to handle alone. Others require professional help. Here’s how to know the difference.

• The estate is worth more than $1 million.
• You’re inheriting real estate in California (or multiple states).
• You’re inheriting a business or significant investment portfolio.
• You inherited retirement accounts and need to plan distributions strategically.
• The deceased had significant income in the year of death.
• You’re unsure whether an estate tax return needs to be filed.

• You’re inheriting straightforward assets (cash, simple stocks).
• The total inheritance is under $100,000.
• There’s no real estate involved.
• The estate is clearly below the federal exemption threshold.

When you do hire help, look for a CPA or tax attorney with specific experience in estate and inheritance matters. Don’t just grab someone who does general tax returns. Inheritance tax planning is specialized, and you want someone who knows California rules inside and out.

Also, consider hiring a financial advisor to help with inherited investment accounts. They can help you diversify, avoid concentration risk, and align inherited assets with your long-term financial goals. Many offer fiduciary services, which means they’re legally required to act in your best interest.

For guidance on finding qualified professionals, the NerdWallet guide to finding a financial advisor has solid criteria for vetting professionals.

One more thing: if you’re dealing with a complex estate or family disputes over inheritance, consider hiring an estate attorney. They can help clarify your rights, navigate probate if necessary, and mediate family conflicts. It’s an investment that often pays for itself by preventing costly mistakes or disputes.

Frequently Asked Questions

Does California charge inheritance tax on money inherited from a parent?

– No. California has no state inheritance tax or estate tax. However, you may owe federal estate tax if the estate exceeds $13.61 million (2024), and you’ll owe income tax on distributions from inherited retirement accounts. The absence of state-level California inheritance tax is one of the few tax breaks available to California heirs.

What happens to inherited property if I sell it within a year?

– You’ll owe capital gains tax on any appreciation after you inherit it (not on appreciation before death, thanks to the step-up in basis). The rate depends on how long you hold it. If you sell within a year, it’s short-term capital gains (taxed as ordinary income, up to 37%). If you hold it over a year, it’s long-term capital gains (15% or 20% federal rate). This is why timing matters.

Can I avoid paying taxes on an inheritance by refusing it?

– Yes, through a formal disclaimer. You have nine months after the person’s death to disclaim (refuse) an inheritance. It then passes to the next beneficiary. This is a legitimate tax strategy if you don’t want the asset or if accepting it would create a larger tax burden than refusing it. Consult a tax professional before doing this—there are specific procedures to follow.

How do I know if an estate tax return needs to be filed?

– If the estate’s gross value exceeds the federal exemption threshold ($13.61 million for 2024), a federal estate tax return (Form 706) must be filed, even if no tax is owed. Some states also require state-level filings. California doesn’t, but if the estate owns property in other states, check those states’ rules. The executor is responsible for filing, but you should verify it gets done.

What’s the step-up in basis, and why does it matter?

– The step-up in basis allows you to use the asset’s fair market value at the date of death as your tax basis, rather than the original purchase price. This eliminates capital gains tax on appreciation that occurred before you inherited it. Example: If your parent bought a house for $200,000 and it’s worth $800,000 at death, your basis is $800,000. If you sell it for $800,000, you owe zero capital gains tax. This is one of the most valuable tax benefits available to heirs and applies to all inherited assets except retirement accounts.

Do I have to pay taxes on inherited retirement accounts immediately?

– Not immediately, but you do have to start taking distributions. Non-spouse heirs must withdraw the entire balance within 10 years (under current rules). You can spread these withdrawals over the 10-year window to minimize your tax burden each year. Spouses have more flexibility and can roll inherited IRAs into their own accounts. Every dollar withdrawn from a traditional IRA is taxable income.

Is there a California state capital gains tax on inherited property?

– California doesn’t have a general capital gains tax, but there is a 3.876% net investment income tax on high earners (income over $250,000 for individuals). This applies to capital gains, dividends, and other investment income. Most people won’t be affected, but high-income heirs should be aware of it. The federal capital gains tax (15% or 20% depending on income) will apply regardless.

What should I do if I inherit a business?

– Inherited businesses are complex from a tax perspective. You’ll get a step-up in basis for the business value at the date of death, which is good. However, you’ll need to understand the business’s tax structure (S-corp, LLC, etc.), any ongoing liabilities, and whether you want to keep it or sell it. Hire a tax professional and potentially a business advisor before making decisions. Selling inherited businesses can trigger capital gains taxes, but the step-up in basis significantly reduces this burden.

Can funeral expenses reduce my inheritance tax burden?

– Funeral expenses can be deducted from the estate before calculating estate tax (if one is owed), but they don’t reduce your personal income taxes as an heir. The executor handles this during estate administration. For more information on whether funeral expenses might be deductible in other contexts, check out our guide on whether funeral expenses are tax deductible.

What if the deceased owed back taxes?

– The estate is responsible for paying any back taxes owed by the deceased. The executor should file the deceased’s final tax return and pay any taxes due before distributing assets to heirs. If taxes were owed but not paid, the IRS can pursue the estate. This is why it’s important to resolve tax issues early in the estate administration process.