The Property Tax
Inheritance Exclusion
MAC TAYLOR • LEGISLATIVE ANALYST • OCTOBER 2017
Summary
Ownership Changes Trigger Higher Tax Bills. Under California’s property tax system, the
change in ownership of a property is an important event. When a property changes hands the taxes
paid for the property typically increase—oen substantially. Local government revenues increase in
turn.
Special Rules for Inherited Properties. While most properties’ tax bills go up at the time of
transfer, three decades ago the Legislature and voters created special rules for inherited properties.
ese rules essentially allow children (or grandchildren) to inherit their parent’s (or grandparent’s)
lower property tax bill.
Inheritance Exclusion Benefits Many but Has Drawbacks. e decision to create an inherited
property exclusion has been consequential. Hundreds of thousands of families have received tax
relief under these rules. As a result, local government property tax collections have been reduced by
a few billion dollars per year. Moreover, allowing children to inherit their parents’ lower property
tax bill has exacerbated inequities among owners of similar properties. It also appears to have
encouraged the conversion of some homes from owner-occupied primary residences to rentals and
other uses.
Revisiting the Inheritance Exclusion. In light of these consequences, the Legislature may
want to revisit the inheritance exclusion. We suggest the Legislature consider what goal it wishes
to achieve with this policy. If the goal is to prevent property taxes from making it prohibitively
expensive for a family to continue to own or occupy a property, the existing policy is craed too
broadly and there are options available to better target the benets. Ultimately, however, any
changes to the inheritance exclusion will have to be placed before voters.
SPECIAL RULES FOR INHERITED PROPERTY
Local Governments Levy Property Taxes.
Local governments in California—cities, counties,
schools, and special districts—levy property taxes
on property owners based on the value of their
property. Property taxes are a major revenue source
for local governments, raising nearly $60billion
annually.
Property Taxes Based on Purchase Price.
Each property owner’s annual property tax bill is
equal to the taxable value of their property—or
assessed value—multiplied by their property tax
rate. Property tax rates are capped at 1percent
plus smaller voter-approved rates to nance local
infrastructure. A property’s assessed value is
based on its purchase price. In the year a property
is purchased, it is taxed at its purchase price.
Each year thereaer, the property’s taxable value
increases by 2percent or the rate of ination,
whichever is lower. is process continues until the
property is sold and again is taxed at its purchase
price (typically referred to as the property being
“reassessed”).
Ownership Changes Increase Property Taxes.
In most years, the market value of most properties
grows faster than 2percent. Because of this, most
properties are taxed at a value well below what
they could be sold for. e taxable value of a
typical property in the state is about two-thirds
of its market value. is dierence widens the
longer a home is owned. Property sales therefore
typically trigger an increase in a property’s assessed
value. is, in turn, leads to higher property tax
collections. For properties that have been owned for
many years, this bump in property taxes typically
is substantial.
Special Rules for Inherited Properties. In
general, when a property is transferred to a new
owner, its assessed value is reset to its purchase
price. e Legislature and voters, however, have
created special rules for inherited properties that
essentially allow children (or grandchildren) to
inherit their parent’s (or grandparent’s) lower
taxable property value. In 1986, voters approved
Proposition58—a legislative constitutional
amendment—which excludes certain property
transfers between parents and children from
reassessment. A decade later, Proposition193
extended this exclusion to transfers between
grandparents and grandchildren if the
grandchildren’s parents are deceased. (roughout
this report, we refer to properties transferred
between parents and children or grandparents
and grandchildren as “inherited property.” is
includes properties transferred before and aer the
death of the parent.) ese exclusions apply to all
inherited primary residences, regardless of value.
ey also apply to up to $1million in aggregate
value of all other types of inherited property, such
as second homes or business properties.
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e decision to create an inherited property
exclusion has been consequential. Hundreds of
thousands of families have received tax relief
under these rules. As a result, local government
property tax collections have
been reduced by a few billion
dollars per year. Moreover,
allowing children to inherit
their parents’ lower property
tax bill has exacerbated
inequities among owners of
similar properties. It also
appears to have inuenced
how inherited properties are
being used, encouraging the
conversion of some homes
from owner-occupied primary
residences to rentals or
other uses. We discuss these
consequences in more detail
below.
Many Have Taken
Advantage of
Inheritance Rules
650,000 Inherited
Properties in Past Decade.
Each year, between 60,000 and
80,000 inherited properties
statewide are exempted from
reassessment. As Figure1
shows, this is around
one-tenth of all properties
transferred each year. Over
the past decade, around
650,000 properties—roughly
5percent of all properties in
CONSEQUENCES OF THE INHERITANCE EXCLUSION
the state—have passed between parents and their
children without reassessment. e vast majority of
properties receiving the inheritance exclusion are
single-family homes.
20,000
40,000
60,000
80,000
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
4
8
12%
2005 2006 2007 2008 2009 2010 2011 2012 2013 20152014
Steady Use of Inheritance Exclusion Over Past Decade
Total Exclusions
Figure 1
As a Share of All Property Transfers
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Many Children Receive
Significant Tax Break.
Typically, the longer a home
is owned, the higher the
property tax increase at the
time of a transfer. Many
inherited properties have been
owned for decades. Because
of this, the tax break provided
to children by allowing them
to avoid reassessment oen
is large. e typical home
inherited in Los Angeles
County during the past
decade had been owned by the
parents for nearly 30 years.
For a home owned this long,
the inheritance exclusion
reduces the child’s property
tax bill by $3,000 to $4,000 per year.
Number of Inherited Properties Likely to
Grow. California property owners are getting
older. e share of homeowners over 65 increased
from 24percent in 2005 to 31percent in 2015. is
trend is likely to continue in coming years as baby
boomers—a major demographic group—continue
to age. is could lead to an increasing number
of older homeowners looking to transition their
homes to their children. is, in turn, could result
in an uptick in the use of the inheritance exclusion.
Recent experience supports this expectation. As
Figure2 shows, during the past decade counties
that had more older homeowners also had more
inheritance exclusions. is suggests a relationship
between aging homeowners and inheritance
exclusions which could lead to a rise in inheritance
exclusions as homeowners get older.
Signicant and Growing Fiscal Cost
Reduction in Property Tax Revenues. e
widespread use of the inheritance exclusion has
had a notable eect on property tax revenues. We
estimate that in 2015-16 parent-to-child exclusions
reduced statewide property tax revenues by around
$1.5billion from what they would be in the absence
of the exclusion. is is about 2.5percent of total
statewide property tax revenue. is share is higher
in some counties, such as Mendocino (9percent),
San Luis Obispo (7percent), El Dorado (6percent),
Sonoma (6percent), and Santa Barbara (5percent).
Figure3 reports our estimates of these scal eects
by county.
Greater Losses Likely in Future. It is likely the
scal eect of this exclusion will grow in future years
as California’s homeowners continue to age and the
use of the inheritance exclusion increases. While
the extent of this increase is dicult to predict, if
Counties With More Older Homeowners
Had More Inheritance Exclusions
Inherited Properties as a Share of All Transfers,
California Counties (2010-2014)
Figure 2
2
4
6
8
10
12
14
16
18%
Least Owners Over 65 Most Owners Over 65
Share of Homeowners Over 65
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Amplication of
Taxpayer Inequities
Inequities Among
Similar Taxpayers. Because
a property’s assessed value
greatly depends on how
long ago it was purchased,
signicant dierences arise
among property owners
solely because they purchased
their properties at dierent
times. Substantial dierences
occur even among property
owners of similar ages,
incomes, and wealth. For
example, there is signicant
variation among similar
homeowners in the Bay
Area. Looking at 45 to 55
year old homeowners with
homes worth $650,000 to
$750,000 and incomes of
$80,000 to $100,000 (values
characteristic of the region),
property tax payments in
2015 ranged from less than
$2,000 to over $8,000.
Inheritance Rules
Amplify Inequities.
Inheritance exclusions
exacerbate underlying
taxpayer inequities. is
is because inheritance
exclusions eectively
lengthen the amount of time
a property can go without
being reassessed. To see how
this happens, consider an example of two identical
homes built in the same neighborhood in 1980:
Millions of DollarsShare of Revenue
Fiscal Effects of Inheritance Exclusions
Estimated Reduction in Annual Property Taxes (2015-16)
Figure 3
Sierra
San Benito
Yuba
Kings
Lake
Sutter
Kern
Yolo
Merced
Imperial
Napa
Nevada
Tulare
Butte
Humboldt
Stanislaus
Solano
Mendocino
San Joaquin
Placer
Santa Cruz
Fresno
El Dorado
Riverside
Monterey
Marin
Sacramento
Ventura
San Luis Obispo
Santa Barbara
Sonoma
San Bernardino
Contra Costa
Alameda
San Francisco
San Mateo
Santa Clara
San Diego
Orange
Los Angeles
$250 10
the relationship suggested by Figure2 is true it is
possible that annual property tax losses attributable
to inheritance exclusions could increase by several
hundred million dollars over the next decade.
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• Home 1 is purchased in 1980 and owned
continuously by the original owners until
their death 50 years later, at which time the
home is inherited by their child.
• Home 2, in contrast, is sold roughly every
15years—around the typical length of
ownership of a home in California.
We trace the property tax bills of these two
homes over several decades in Figure4 under
the assumption that the homes appreciate at
historically typical rates for California homes. By
2030, home1’s bill would be one-third as much
as home2’s bill. In the absence of the inheritance
exclusion, when home1 passes to the original
owner’s child it would be reassessed. is would
erase much of the dierence in property tax
payments between home1 and home2. With the
inheritance exclusion, however, the new owner of
home1 maintains their parent’s lower tax payment.
Over the child’s lifetime, the dierence in tax
payments between home1 and home2 continues
to grow. By 2060 home1’s bill will be one-sixth as
much as home2’s bill.
Unintended Housing Market Eects
Many Inherited Primary Residences
Converted to Other Uses. Inheritance exclusions
appear to be encouraging children to hold on to
their parents’ homes to use as rentals or other
purposes instead of putting them on the for
sale market. A look at inherited homes in Los
Angeles County during the last decade supports
this nding. Figure5 shows the share of homes
that received the homeowner’s exemption—a
tax reduction available only for primary
residences—before and aer inheritance. Before
inheritance, about 70percent of homes claimed
the homeowner’s exemption, compared to about
40percent aer inheritance. is suggests that
many of these homes are being converted from
primary residences to other uses.
It is possible that this trend arises because
people intrinsically make dierent decisions about
inherited property regardless
of their tax treatment. A
closer look at the data from
Los Angeles County, however,
suggests otherwise. Figure6
breaks down the share of
primary residences converted
to other uses by the amount
of tax savings received by the
child. As Figure6 shows, the
share of primary residences
converted to other uses is
highest among those receiving
the most tax savings. A little
over 60percent of children
receiving the highest tax
savings converted their
Home 1
Home 1 Without
Inheritance Exclusion
Home 2
Home 1 is owned continuously by
the same owners until their death
in 2030 and is then inherited by
their child.
Home 2 is sold roughly every
15 years.
Inheritance Exclusion Amplifies Taxpayer Inequities
Property Tax Bill of Two Hypothetical Identical Homes (2016 Dollars)
Figure 4
2,000
4,000
6,000
8,000
10,000
$12,000
1980 1990 2000 2010 2020 2030 2040 2050 2060
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Inherited Primary Residences
Being Converted to Other Uses
Share of Homes Claiming Homeowner's Exemption
Los Angeles County, 2007-2014
Figure 5
10
20
30
40
50
60
70%
After TransferBefore Transfer
Inherited Homes
Other Home Sales
inherited home to another
use, compared to just under
half of children receiving the
least savings. is suggests
that the tax savings provided
by the inheritance exclusion
may be factoring into the
decision of some children to
convert their parent’s primary
residence to rentals or other
uses.
Contributes to Limited
Availability of Homes for
Sale. e conversion of
inherited properties from
primary residences to other
uses could be exacerbating
challenges for home buyers
created by the state’s tight
housing markets. In many
parts of California, there is a
very limited supply of homes
for sale and buying a home is
highly competitive. Figure7
(see next page) shows that the
inventory of homes for sale
is consistently more limited
in California than the rest
of the country. is limited
inventory—a consequence
of many factors including
too little home building and
an aging population—has
driven up the price of housing
in California and made the
home buying experience
more dicult for many.
When inherited homes are
held o the for sale market,
Higher Tax Savings May Encourage Conversions
Share of Inherited Primary Residences Converted to Other Uses
Los Angeles County, 2006-2016
Figure 6
10
20
30
40
50
60%
Least Savings Most Savings
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these issues are amplied.
On the ip side, the shi of
inherited homes to the rental
market could put downward
pressure on rents. e data
we reviewed, however, does
not allow us to determine
how many properties are
being converted to rentals as
opposed to other uses—such
as vacation homes. On net,
the shi of homes from
the for-sale market to the
rental market likely results
in fewer Californians being
homeowners and more being
renters.
REVISITING THE INHERITANCE EXCLUSION
It has been decades since Californians voted to
create the inherited property exclusion. Since then,
this decision has had signicant consequences,
yet little attention has been paid to reviewing it.
Moreover, indications are that use of the exclusion
will grow in the future. In light of this, the
Legislature may want to revisit the inheritance
exclusion. As a starting point, the Legislature
would want to consider what goal it wishes to
achieve by having an inheritance exclusion. Is the
goal to ensure that a family continues to occupy a
particular property? Or to maintain ownership of a
particular property within a family? Or to promote
property inheritance in and of itself?
Dierent goals suggest dierent policies. If
the goal is to unconditionally promote property
inheritance, maintaining the existing inheritance
exclusion makes sense. If, however, the goal is more
narrow—such as making sure a family continues
to occupy a particular home—the scope of the
existing inheritance exclusion is far too broad.
Reasons the Existing Policy May Be Too Broad
Property Taxes May Not Be Big Barrier to
Continued Ownership. One potential rationale
for the inheritance exclusion is to prevent property
taxes from making it prohibitively expensive for
a family continue to own a particular property.
e concern may be that if a property is reassessed
at inheritance the beneciary will be unable to
aord the higher property tax payment, forcing
them to sell the property. ere are reasons,
however, to believe that many beneciaries are in
a comparatively good nancial situation to absorb
the costs resulting from reassessment:
• Children of Homeowners Tend to Be
More Afuent. Children of homeowners
tend to be nancially better o as adults.
Limited Availability of Homes for Sale in California
Number of Homes for Sale as a Share of All Single Family Homes
Figure 7
California
U.S.
1
2
3%
2010 2011 2012 2013 2014 2015 2016 2017
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Data from the Panel Survey of Income
Dynamics suggests that Californians who
grew up in a home owned by their parents
had a median income over $70,000 in
2015, compared to less than $50,000 for
those whose parents were renters. Beyond
income, several nationwide studies have
found that children of homeowners tend to
be better o as adults in various categories
including educational attainment and
homeownership.
• Many Inherited Properties Have Low
Ownership Costs. In addition to property
taxes homeowners face costs for their
mortgage, insurance, maintenance, and
repairs. ese costs tend to be lower
for properties that have been owned
for many years—as is true of many
inherited properties—largely because their
mortgages have been paid o. According
to American Community Survey data, in
2015 just under 60percent of homes owned
30 years or longer were owned free and
clear, compared to less than a quarter of all
homes. Consequently, monthly ownership
costs for these homeowners were around
$1,000 less than the typical homeowner
($1,650 vs. $670). Because most inherited
homes have been owned for decades,
children typically are receiving a property
with lower ownership costs.
• Property Inheritance Provides Financial
Flexibility. In addition to lower ownership
costs, an additional benet of inheriting
a property without a mortgage is a
signicant increase in borrowing capacity.
Many inherited properties have signicant
equity. is oers beneciaries the option
of accessing cash through nancial
instruments like home equity loans.
Many Children Not Occupying Inherited
Properties. Another potential rationale for the
inheritance exclusion is to ensure the continued
occupancy of a property by a single family. Many
children, however, do not appear to be occupying
their inherited properties. As discussed earlier,
it appears that many inherited homes are being
converted to rentals or other uses. As a result, we
found that in Los Angeles County only a minority
of homes inherited over the last decade are
claiming the homeowner’s exemption. is suggests
that in most cases, the family is not continuing to
occupy the inherited property.
Potential Alternatives
If the Legislature feels the existing policy is
too broad, it has several options to better focus the
exclusion on achieving particular goals. In addition
to better aligning the policy with a particular
objective, narrowing the exclusion would help
to minimize some of the drawbacks discussed
in the prior section. Below are some options the
Legislature could consider. ese options could be
adopted individually or could be combined. Any
changes ultimately would have to be placed before
voters for their approval.
Limit to Homes Used as a Primary Residence.
One option is to limit the exclusion to homes that
are occupied by the family member following
inheritance. Inherited homes used as rentals or
second homes would be subject to reassessment.
Such a change could possibly cut in half the
property tax losses resulting from the existing
exclusion.
Apply Means Testing. Another option is to
require means testing to determine eligibility for
the exclusion. e Legislature could set an income
threshold under which a child’s income would have
to fall to be eligible for the inheritance exclusion.
Phase In Property Tax Increase. A third
option is to phase in over several years the property
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tax increase resulting from the reassessment of
an inherited property. is change would reduce
the overall nancial benet provided by the
exclusion—in recognition of the relative auence
of many beneciaries—while still providing some
short-term relief. e interim period during which
the increase is phased in could provide the family
member time to make nancial arrangements to
accommodate the ongoing ownership costs of their
inherited property.
CONCLUSION
When a property changes hands the taxes
paid for the property typically increase—oen
substantially. is is not true, however, for
most inherited property. ree decades ago, the
Legislature and voters decided that most inherited
property should be excluded from reassessment.
is has been a consequential decision. Many have
beneted from the tax savings this policy aords.
Nonetheless, the inheritance exclusion raises some
policy concerns about taxpayer equity and adverse
eects on real estate markets.
In light of these consequences, the Legislature
may want to revisit the inheritance exclusion.
We suggest the Legislature consider what goal it
wishes to achieve with this policy. If the goal is to
prevent property taxes from making it prohibitively
expensive for a family to continue to occupy a
home, the existing policy is craed too broadly
and there are options available to better target
the benets. Ultimately, however, any changes to
the inheritance exclusion would have to be placed
before voters.
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LAO Publications
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