November 8, 2025

This is a Deep Dive Article which helps homeowners understand the “Loop Holes” in the tax code for their principle primary residence.

The fact is, many homeowners feel “trapped “ in their home due to various taxes, and for many there is no reason to postpone the move they would like to make.

Get ready for a long read, because this article explains in detail the techniques homeowners use to legally reduce and eliminate taxes when they sell their home:

Let’s start with how homeowners can transfer their low property tax assessment to another property thereby keeping their current Low Property Taxes: 

 

LOOP HOLE – Proposition 19:

Prop 19 makes it possible for age 55+ homeowners to transfer the low property tax assessment for their personal residence to another home anywhere in the State of California.

According to its supporters, Proposition 19 was designed to benefit California’s housing market, provide tax savings for homeowners and create new homeownership opportunities.

• Homeowners who are 55+ or severely disabled can transfer the property tax base of their existing home to another home anywhere in California, regardless of price, to be closer to family or medical care, downsize, or move to a home that better meets their needs without a property tax increase (with an adjustment upward to their tax basis if the replacement property is of greater value).
• Allows wildfire victims to transfer the property tax base of their damaged home to a replacement home anywhere in California.
• Creates housing opportunities to build more senior housing and retirement communities.
• Opens up more housing inventory in neighborhoods throughout California, providing homeownership opportunities for renters, young families, and first-time homeowners.

 Here is a Q&A for Proposition 19 which should answer your questions:

What are the new rules for homeowners to transfer their low property tax base to another home under Prop 19?

• Older homeowners, those who are severely disabled, or victims of wildfires or natural disasters can move anywhere in the state without location restrictions.
• Qualified homeowners can transfer their existing property tax base to another property regardless of the cost of the replacement home (with an adjustment upward to their tax basis if the replacement property is of greater value).
• Homeowners can transfer the property tax base of their existing home to a replacement home up to three times.
• The original property and the replacement property must be the principal residence of the homeowner.

Who is eligible to access these new tax benefits?

• Homeowners who are 55 years or older
• Severely disabled
• Victims of California wildfires or natural disasters

How does Prop 19 work when purchasing a new home for the same price (or less) than the original home? 

If the purchase price of the replacement home is equal to (or less than) the sales price of the existing home, even if the replacement home is in another county, the tax base of the replacement home will remain the same as the original residence. (“Sales price” means full cash value.)

Example #1:  A senior couple on a fixed income lives in a home valued at $600,000. They pay $2,200 in property taxes (based on the $200,000 original purchase price). They find a $600,000 home to purchase near family in another county but can’t afford the new $6,600 annual property tax bill that comes with moving – it could cost $4,400 more in annual property taxes to move.

Under Proposition 19: The senior couple can purchase the $600,000 home in another county without a property tax increase. Prop 19 allows these homeowners to transfer the tax base of their original home to the replacement home, saving $4,400 in annual property taxes. 

How does Prop 19 work when purchasing another home that costs more than the sales price of the original home?

If the sale price of the replacement home costs more than the price of the existing home, qualified homeowners can blend the tax base of their original home with the tax base of the new home. The new, adjusted property tax base of the replacement home takes the tax base of the original home and adds the difference between the sale price of the new home and the original home. (“Sales price” means full cash value.)

Example #2:  Another senior couple with a home valued at $600,000 (also paying $2,200 in property taxes) wants to downsize from the two-story home that is too big for their needs, is too expensive to maintain, and has stairs that are difficult for them to use. They want to downsize to a more manageable home in a newly built retirement community nearby for $700,000, but they can’t afford the $7,700 spike in property taxes that comes with moving.

Under Proposition 19: This couple will save $4,400 in annual property taxes. Prop 19 allows homeowners to keep their existing Prop 13 tax base and transfer it to a more expensive home. The property tax base of the new home is determined by adding the difference between the sales price of the replacement home ($700,000) and the original home ($600,000) to the tax base of the original home ($200,000). In this example, the couple would pay $3,300* in property taxes, instead of $7,700 in property taxes. (*The tax savings could be greater depending on the definition of “equal or lesser” value). Prop 19 Sample

What was the law before the enactment of Prop 19?

Under Prop 60 and Prop 90, seniors and disabled homeowners faced location and price limits, were restricted to transfers within the same county (with some exceptions), could only transfer if the price of the replacement home was less than or equal to the value of the original home, and were only allowed one transfer.

If an eligible homeowner used their one-time base year value transfer under Proposition 60/90, can they transfer that base year value three more times under Proposition 19?

Yes, according to the Board of Equalization,* three transfers under Proposition 19 will be allowed regardless of whether a property owner transferred a base year value in the past under Propositions 60/90 and Proposition 110. Future legislation may impact the operation of Proposition 19 and any updates will be posted on the Board of Equalization’s website.*

The Board of Equalization has posted on its site the above FAQs addressing the purchase or sale of property prior to April 1, 2021. These questions are qualified with the following disclaimer:

Proposition 19’s provisions will become operative on February 16, 2021 (intergenerational transfer exclusion) and April 1, 2021 (base year value transfer).

Unfortunately, Proposition 19 did not have companion legislation that would have clarified a host of issues. Therefore, these frequently asked questions (FAQs) are intended to help property taxpayers navigate those new provisions in light of Proposition 19’s lack of clarity or silence.

It is anticipated that these FAQs will be updated periodically with additional questions, particularly if legislation is enacted or further guidance is issued by the Board.

Please check back often for updates. https://www.boe.ca.gov/prop19/#FAQs

The information contained herein is intended to provide general information and is not intended as a substitute for individual legal advice. Specific examples used are only general examples, and the actual amount of property taxes owed for any person will depend on the specific situation of the individual and a wide variety of other factors. Therefore, all persons are directed to seek the advice of an attorney regarding their specific tax and legal situation.

Now, let’s discuss Capital Gains Taxes

NOTE: If you are unaware of how capital gains taxes are generally computed in California for personal primary residences, CLICK HERE to read an article on the topic.

If you are the surviving spouse, you most likely have zero capital gains taxes to be concerned about due to Stepped Up Basis.  Also, if you have lived in your residence for two out of the last five years, you may qualify for a $250,000 or $500,000 exemption under IRS Section 121.  Here is how these loop holes work:

 

LOOP HOLE –  Stepped Up Basis:

This IRS rule allows the surviving spouse to sell “capital gains tax free” within 12 months of date of death (of spouse).

After 12 months, Stepped Up Basis can be combined with IRS Section 121 to get an additional $250,000 capital gains tax free provided home is still the principle primary residence.

According to an informative article written by Kimberlee Leanard in Seeking Alpha, a “step-up in basis” is an adjustment to the value of appreciated assets upon inheritance.

Here is a Q&A for Stepped Up Basis which should answer your questions:

What Is the Step-Up in Basis?

Personal residences can appreciate massively before they pass to heirs. It is not uncommon for a personal residence owned for 20 years in coastal areas of California to appreciate $500,000, $1,000,000, $2,000,000 or more.

When someone inherits real estate and later sells it, the IRS allows the date of inheritance to establish the cost basis rather than the date of purchase by the person it was inherited from.  This allowance by the IRS is called “Step-Up Basis”.

The “step-up in basis” is part of the IRS inheritance tax rules that allow the person inheriting an asset to use the fair market value of the asset at the time of inheritance as the cost basis for taxes when selling the asset. It is designed to reduce the capital gains tax for heirs on inherited assets.

Note: It’s important to understand that a step-up in basis only happens after a benefactor dies—taxes on assets transferred before death are subject to the original cost basis.

What is the Purpose of the Step-Up In Basis?

The rationale behind this rule is that property may have been held for many years, if not decades, with considerable gains. Taxing the asset based on the original purchase price can seem unfair and, in some cases, cannot easily be determined if the original purchase records exist.

For example, an Orange County, CA home purchased in 1950 may have only cost $10,000 at the time. If this home transfers ownership upon the owner’s death in 2022, and is valued at that time at $950,000, the beneficiary could be responsible for a $940,000 taxable capital gain if they were to sell the property at that time.

By using the IRS inheritance tax rules, “step-up in basis”, the beneficiary’s adjusted cost basis becomes the $950,000 (appraised) value of the home at the time of death and they do not inherit the huge unrealized capital gain liability for the prior 71 years.

How Step-Up Basis Is Calculated?

The step-up in basis is calculated based on the date of death. This calculation is relatively simple; a snapshot is taken of the fair market value on the date of death. For investment real estate or personal residences, a fair market value appraisal is used to determine value on the date of death.

Step-Up In Basis Examples

Let’s look at an example to determine how the step-up in basis works.

Example #1: 

Bill & Sue are a married couple. They purchased their personal residence in 1970 for $25,000 in Southern California, a community property state.

The couple created a revocable living trust in 2000, placing all of their assets in it. Bill died in 2022. At the time of his death, the personal residence was free of loans and valued at $1,525,000.  This is the new cost basis for Sue on the personal residence which is now owned by her alone.

Sue can afford to stay in the home because the house is free of loans and the property taxes remain very low thanks to Proposition 13.  So, she elects to spend the rest of 2022 living in the home and celebrate one more holiday season at her personal residence.

In early 2023, Sue decided to go live closer to her daughter and grandchildren, so she sold the property for $1,600,000 netting $1,520,000 after closing costs and a few repairs.  Since the “step-up basis” is more than her net proceeds, there is no capital gain tax on the $1,520,000 proceeds from the escrow.

Sue buys a townhouse near her daughter for $520,000 and puts $1,000,000 into a safe investment which pays her $4,000 per month to supplement her other retirement income.  She can afford to travel with her daughter and friends when the opportunities arise, and she lives very comfortably.

Example #2:  

Robert & Darlene are a married couple.  They have a son named Robert Jr. and daughter named Jane.  Robert & Darlene purchased their personal residence in 1980 for $50,000 in Southern California, a community property state.

The couple created a revocable living trust in 2000, placing all of their assets in it. Robert died in early 2022 followed a few months later by Darlene.  At the time of her death, the personal residence had a loan balance of $500,000 and valued at $1,900,000.  This is the new cost basis for Robert Jr. and Jane who inherited the property 50% each upon the death of their father and mother.

Both Robert Jr. and Jane live outside of Southern California. Neither of them wants to live in the old family home (and buy the other out).

Due to Proposition 19, which was enacted in 2021, the property taxes will increase to approximately $21,000 since neither Robert Jr. or Jane are able to move into the property and claim an exemption.

Living outside the area, neither Robert Jr. nor Jane can effectively manage the old family home as a rental. The increase in property taxes to $1,750 per month, mortgage payments, insurance, maintenance, plus the cost of a property manager makes the cash flows from renting the property unattractive.

In early 2023 when Robert Jr. & Jane learn IRS inheritance tax rule “step-up basis” allows them to receive the proceeds from the sale of the house “tax free”, they decide to sell the property for $1,900,000.  They net $1,800,000 after deducting accumulated interest, closing costs and a few repairs.  The “step-up basis” is more than their net proceeds, so there is no capital gain tax on the proceeds from the escrow after paying off the $500,000 loan.  The net after paying off the loan for the property is $1,300,000, so each gets a wire transfer of approximately $650,000 at close of escrow.

Robert Jr. uses the proceeds to pay off his mortgage and takes early retirement.  Jane uses her funds to pay for college for her two children, and the remainder goes into investments to fund her future retirement.

What is the Bottom Line?

The step-up in basis is a valuable way for beneficiaries to preserve their inheritance. It allows them to use the present-day market value of assets rather than original purchase prices, often saving considerable amounts in capital gains taxes when assets are ultimately sold.

Here is the original article from Kimberlee Leanard, information on Proposition 19, and other articles on the subject:

• https://seekingalpha.com/article/4458768-step-up-in-basis#what-is-the-step-up-in-basis
• https://www.boe.ca.gov/prop19/
• https://www.naimishlewislaw.com/estate-planning/proposition-19-property-tax-changes-and-inheritance/
• https://www.quickenloans.com/learn/step-up-in-basis

 

LOOP HOLE –  IRS Section 121 Exclusion

Section 121 is an IRS rule that allows you to exclude from taxable income a gain of up to $250,000 from the sale of your principal residence. A couple filing a joint return gets to exclude up to $500,000 provided they qualify.

To get the exclusion a taxpayer must own and use the home as their main residence for a period adding up to two years out of the five years before it is sold. Verify the date(s) of your occupancy of the home with your tax advisor based on past tax returns.

The Section 121 Exclusion, also known as the principal residence tax exclusion:

• It lets people who sell their primary homes put the proceeds from the sale into another home without having to pay taxes on the gain.
• There is no requirement that proceeds from a home sale be used to purchase another home in order to claim the exclusion.
• U.S. taxpayers also qualify for the principal residence tax exclusion if the principal residence is outside the United States.

Here is a Q&A for IRS Section 121 which should answer your questions:

What type of sales do not qualify for Section 121?

• The exclusion is tailored to deny similar tax benefits to investors who buy homes for rental.
• People who sell secondary residences such as vacation homes cannot use the exclusion.

The main restriction on using the Section 121 exclusion is the ownership and use test.

This requires that the taxpayer has owned the home and used it as a primary residence for at least 24 months out of the previous 60 months. The 60-month period ends on the date the home is sold. The 24 months do not have to be consecutive.

For instance, a taxpayer could qualify for the exemption if the taxpayer lived in the home for a year, moved out for three years, and then used it again as a primary residence the last year. Also, the ownership and use tests can be met during different two-year periods.

A homeowner who uses the home for business purposes, such as rental property, for part of the preceding five years would only be able to excluded a portion of the gain, however. The amount of the gain that can be excluded is determined by the proportion of time the home was used for business purposes. For a taxpayer who lived in a home for two of the five years and rented it for three of the five years, for example, three-fifths of the gain on the sale could not be excluded. That portion of the gain would be treated as income.

Another limitation on the exclusion is that the taxpayer can only use it every two years. If a taxpayer sold a home and took the exclusion at any time during the two years before the date of the home’s sale, the exclusion wouldn’t apply.

Special Exemptions for change of employment and health issues:

There are some special cases when a home seller can use the exclusion test more liberally. For instance, when a home seller has had a change of employment or had health issues or experienced other unforeseen circumstances.

There is also a specific provision for taxpayers or their spouses who are serving in the military and have been stationed for more than 90 days more than 50 miles from home or ordered to live in government housing. In these cases, the taxpayer can elect to suspend the usual five-year period for up to 10 years. A similar exemption applies to taxpayers or spouses in the government foreign service or intelligence community.

Summary:  A home that has been a principal residence for 2 out of the last 5 years and was not a rental for any of that period can qualify for significant tax reduction using the Section 121 Exclusion

• Section 121 allows the excluding from income up to $250,000 for an individual taxpayer and $500,000 for a couple filing jointly. The exclusion is only for people who own and use a property as their primary residence for two of the five years before the sale.
• Section 121 cannot be used by real estate investment properties, rental houses, second and vacation homes, or business property.
• Section 121 can only be used once every two years.

Keep in mind, the amount of capital gains which exceed the Section 121 exclusion will be taxed by both the IRS and the State of California. 

If you have a highly appreciated home where the gain is well above the Section 121 exclusion, it is essential that you discuss your tax situation with your CPA to consider all the alternatives which may defer or eliminate capital gains taxes.

I have additional articles on my real estate blog that discuss your alternatives.  Here is one which outlines some of your choices: https://scotcampbell.com/2022/12/08/capitalgains

For additional information please contact your tax expert and review IRS guidance: https://www.irs.gov/taxtopics/tc701

Here is the most important piece of advice I can give you:  Seek Tax Advice Before Transacting!  The information contained herein is intended to provide general information and is not intended as a substitute for individual legal advice. Specific examples used are only general examples, and the actual amount of capital gains and property taxes owed for any person will depend on the specific situation of the individual and a wide variety of other factors. Therefore, all persons are directed to seek the advice of an attorney regarding their specific tax and legal situation.

 

Real Estate Marketplace Observations by Scot Campbell – Real Estate Broker

BACKGROUND: The sale of a significantly appreciated personal residence often requires the payment of substantial capital gains tax on the profit exceeding the $250,000 per spouse IRS Section 121 threshold.

Some long-term homeowners are fortunate enough to have much more appreciation: $1 to $4 million is certainly not uncommon in Coastal Orange County. There is little appetite for such long-term homeowners to sell when capital gains taxes can take 35+ percent of the profit over the $250,000 per spouse threshold.

HOMEOWNERS OFTEN ASK ME: How can I reduce capital gains taxes when selling my  long term home now that I want something more suitable for my current lifestyle (or budget)?

Option #1: There is little or no capital gains taxes due if Stepped Up Basis is applicable:  The “step-up in basis” is part of the IRS inheritance tax rules that allow surviving spouse inheriting an asset to use the fair market value of the asset at the time of inheritance as the cost basis for taxes when the asset is sold.

Translation:  A widow(er) who has lived in the long term principle primary residence can sell the property and have very little or no capital gains taxes due relating to the appreciation which occurred from the date of purchase until the date of death of their spouse.  Additionally, if after the date of death of their spouse the home has appreciated $250,000 or less, and the home has been the principle primary residence of the surviving spouse for 2 out of the last 5 years, then there will be no capital gains tax due for the period after the date of death until the sale (IRS Section 121).

So, when Stepped Up Basis is applicable, there is no “capital gains tax” reason which would limit the desire of a widow(er) to downsize to another property or relocate closer to family or friends. 

Furthermore, Proposition 19 has eliminated the transfer of the low property tax assessment to adult children who inherit the home, unless they move into the property making it their principle primary residence.  So, after Proposition 19, there is no incentive to keep the family home so adult children can inherit it to keep as a “rental”. 

Option #2: Rent Out Existing Home, then Buy or Rent a More Suitable Home: A very simple option is to rent out the existing home, and then Buy (if you can qualify without the sale of the existing home) or Rent a home which is better in terms of location, layout, size, and monthly budget. Rental income from existing home funds the payments (or rent) on the new home.

Important: The existing home reduced capital gains rate (IRS section 121), $250,000 profit exemption per spouse, expires on the 3-year anniversary of the date you move out (so selling before the 3 year deadline is advisable). Or, once the existing home is considered a “rental” under the tax code, you could potentially do a 1031 Tax Deferred Exchange into another rental property which has better cash flows or is better located for ease of management. When the existing home is rented out for the long run or exchanged into another rental, the equity in the existing home has been converted to “an investment” which generates income. The rental income is taxable, but capital gains taxes are deferred.

Option #3: Sell Existing Home using a Traditional Installment Sale: One well known strategy for homeowners (who own their home Free & Clear) is to defer and potentially lower capital gains taxes by breaking up the cash flows from the sale over several years using a Traditional Installment Sale (Seller Carry Back Loan). Home sellers like that Interest income from the carry back loan is higher than a bank savings account, and it is nice to collect interest income on money that would have been paid in taxes (if all proceeds were paid out at close of escrow). Although a large down payment can reduce risk to acceptable levels, some home sellers do not like the risk of missed or late payments and would prefer not to worry about an “early payoff” (which would trigger capital gains taxes).

Option #4: Sell using a Structured Installment Sale: A strategy with less credit risk which homeowners are using to break up the cash flows from the sale over several years is the “Structured Installment Sale” with installment payments made by *A+ Rated Life Insurance Company. Unlike a Traditional Installment Sale, the (annuity) payments are reliably made, and there is no risk of an early payoff.

Other things homeowners like about Structured Installment Sales: The house does not have to be Free & Clear. At closing, the buyer obtains a new loan (or pays cash), and the existing mortgage is paid off. A “chunk of money” can be taken out of the escrow to buy another home (verify tax considerations for these funds), then the balance of the escrow proceeds are taken in the form of reliable monthly installments (annuity from *A+ Rated life insurance company at possibly a much lower capital gains tax rate than if all the funds were paid at the closing).

Important – This article is Not Intended to be specific tax advice: Receiving rent or installment payments from either type of Installment Sale tends to be more beneficial under the tax code when ordinary income is low (often when one is retired). Do NOT sell a highly appreciated home/investment property or attempt to do a 1031 Exchange, Installment Sale, or Structured Installment Sale without advice from a CPA/Tax/Legal Expert who understands your complete situation. Advice and council of a Realtor and Qualified Insurance Broker who are familiar with the IRS rules & best practices are an absolute necessity prior to entering into a purchase contract involving a Structured Installment Sale. *A+ Rating from AM Best.

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SCOT CAMPBELL | Global Luxury Property Specialist | Coldwell Banker-Campbell Realtors

714.336.0394 Mobile / scot@campbellrealtors.com / www.scotcampbell.com / DRE #00943759