How Capital Gains Taxes on Real Estate Interact with California Proposition 19 in San Luis Obispo
California real estate owners navigating the tax landscape must consider both capital gains taxes and property tax reassessments. Proposition 19, passed in 2020, brought significant changes to property tax rules, particularly affecting intergenerational transfers and base-year value transfers. Understanding how capital gains taxes interact with Prop 19 can help homeowners and investors make informed financial decisions.
Impact in San Luis Obispo
Due to Proposition 13 limits, many long-term homeowners in San Luis Obispo County have property tax bases far below current fair market values (San Luis Obispo Assessor). As of February 2025, the median sale price in San Luis Obispo County was $915,000, up 5.5% year-over-year, while in the city of San Luis Obispo, it was $975,000, up 17.9% (Redfin). Homeowners who sell after long-term ownership could face significant capital gains, even after applying the IRS exclusion.
Capital Gains Tax Overview
When selling real estate, capital gains tax applies to the profit from the sale, calculated as:
Capital Gain = Sale Price – (Purchase Price + Improvements + Selling Expenses)
For primary residences, the IRS allows a capital gains exclusion of up to $250,000 for single filers and $500,000 for married couples filing jointly, provided they have lived in the home for at least two of the last five years (IRS Source). Beyond this exclusion, capital gains are taxed at federal rates ranging from 0% to 20%, plus a 3.8% net investment income tax for high earners (IRS Source). California also taxes capital gains as ordinary income, with rates reaching as high as 13.3% (FTB Source).
How the IRS Determines Basis
The IRS determines cost basis based on fair market value (FMV) rather than the assessed value used for property taxes. The basis varies depending on how the property is acquired:
- Purchased Properties: Basis is the purchase price plus closing costs and capital improvements.
- Inherited Properties: Basis is the FMV at the date of the original owner’s death, meaning heirs receive a “step-up” in basis to minimize capital gains taxes (IRS Source).
- Gifted Properties: Basis is carried over from the original owner, meaning potential higher capital gains taxes when sold.
Since assessed values for property taxes (under Prop 13) are often lower than FMV, they do not impact IRS capital gains calculations (San Luis Obispo Assessor).
Proposition 19 and Property Tax Reassessment
Prop 19 affects property tax reassessments in two key ways:
- Intergenerational Transfers: Under previous law, parents could transfer a home to their children without a property tax reassessment, preserving the lower tax base. Prop 19 now limits this benefit to cases where the child uses the home as a primary residence and caps the reassessed value at the home’s market value minus $1 million (CA Board of Equalization). If the child does not use the home as a primary residence, it is fully reassessed at market value.
- Base-Year Value Transfers for Homeowners 55+: Eligible homeowners (age 55+, disabled, or victims of natural disasters) can transfer their property tax base up to three times when moving within California, even to a higher-valued home (with an adjustment to the taxable value if the new home costs more than the old one) (CA BOE).
Interaction Between Capital Gains and Prop 19
Selling an Inherited Property
- Step-Up in Basis: Heirs receive a step-up in cost basis to the property’s fair market value at the time of the original owner’s death, minimizing capital gains taxes if sold shortly after inheritance (IRS Source).
- Prop 19 Reassessment: If heirs do not use the home as a primary residence, property taxes will be reassessed at full market value, potentially making it more costly to hold the property long-term.
- Capital Gains Implications: If the heir sells the property, capital gains are calculated based on the stepped-up basis, reducing taxable gains compared to a property acquired via purchase.
Moving and Carrying Over Property Tax Basis
- Homeowners over 55 can retain their lower property tax base when moving, reducing ongoing costs.
- However, selling the original property may trigger capital gains taxes if the gain exceeds the $250K/$500K exemption.
- If a homeowner keeps the original home as a rental, it loses its primary residence tax exclusion for future capital gains.
Key Takeaways for Homeowners and Investors
- Inherited Properties: If keeping an inherited property as a rental, expect higher property taxes due to reassessment. Selling soon after inheritance can minimize capital gains taxes due to the stepped-up basis.
- Downsizing for Seniors: Prop 19 allows transferring a lower tax basis, but selling a highly appreciated home could trigger significant capital gains taxes beyond the exclusion limit.
- Strategic Timing: If planning to pass a home to heirs, consider whether they will use it as a primary residence to benefit from Prop 19’s tax treatment.
By understanding the interplay between capital gains taxes and Prop 19 property tax reassessment, California homeowners can make more strategic real estate decisions while minimizing tax burdens. Consulting with the experienced San Luis Obispo estate planner Klaus Gottlieb at wealthcarelawyer.com can help navigate these rules effectively, avoiding costly mistakes when bequeathing property to the next generation.
