California Estate Tax Loopholes: Strategies Real Estate Investors Use to Cut Millions in 2025
Most California real estate investors believe the state estate tax is a non-issue, and that their properties will automatically transfer with a simple will. That blind spot could cost your family millions. As of September 9, 2025, the landscape for high-net-worth property owners is more dangerous—and more ripe for opportunity—than most advisors admit. If your net worth exceeds $10 million, ignoring the new federal exemption sunset, the absence of a state estate tax, or the slew of recent IRS audits and trust scrutiny will jeopardize your entire legacy.
Fast Tax Fact: Clarifying the California Estate Tax Myth in 2025
There is no formal California estate tax for 2025. However, federal estate taxes still apply—and with the exemption scheduled to plummet in the next two years, a $5 million+ hit is looming for unprepared families. Add to that new scrutiny on trust structures, and the window for strategic moves is now. See our full California Guide to Estate & Legacy Tax Planning for a deeper dive.
The New Reality: Federal Estate Tax Risks Facing California Investors
The federal estate tax exemption remains at $13.61M per person for 2025, but is scheduled to shrink by nearly half by 2026. That means countless California investors—many with ‘paper’ real estate wealth—suddenly face a 40% estate tax on assets above approximately $7 million (indexing varies). A married couple with a $20M estate (e.g., multifamily, coastal homes, and liquid assets) could see their tax exposure double from zero to over $5.2 million, unless they act now.
Many investors mistakenly believe that California’s lack of estate tax shields them. It doesn’t—federal taxes still apply, and recent IRS data (see IRS estate tax FAQ) show an audit spike on high-value trusts and indirect property transfers. Recent audits have focused heavily on:
- Incorrect use of irrevocable trusts
- Discounted transfers to family partnerships
- Improper step-up in basis calculations on inherited property
Those who delay gifting or fail to restructure property holdings before 2026 could face rapid loss of wealth efficiency and stewardship.
Strategy #1: Leveraging Trusts (And Avoiding Common Audit Traps)
High-net-worth real estate holders in California have traditionally used trusts—especially irrevocable life insurance trusts (ILITs) and grantor retained annuity trusts (GRATs)—to shift future appreciation outside their taxable estate. However, the IRS is increasing scrutiny for, among others, improper funding and retained interests. For example:
- Putting leveraged multifamily assets into a Nevada “dynasty” trust, gifting current value, and letting all appreciation rise outside the estate.
- Funding a GRAT with a $15M property interest, securing future appreciation tax-free if structured per IRS Notice 2004-72.
Done right, these vehicles avoid the 40% estate tax. But, per recent audits, missing a step or funding with illiquid or mismatched assets triggers IRS challenge—often retroactively.
Warning: Step-Up Basis Missteps
Failing to report proper step-up value (the stepped-up basis) on California real estate inherited in a trust can result in double-taxation for heirs and even gift tax retrocharges. Always coordinate between CPA and estate attorney, and secure current appraisals within 6 months of death (see Schedule A of Form 706).
Strategy #2: Intra-family Sales and Valuation Discounts
Some California investors take advantage of minority and marketability discounts by selling or gifting partial interests in real estate assets to family members or family limited partnerships. By transferring a 30% minority stake in a $10 million property to heirs, an investor may reduce the taxable value for gift and estate tax reporting by as much as 25%—a difference of $750,000 per $3M block transferred.
- Pro Tip: To withstand IRS scrutiny, all discounts must be substantiated with certified appraisals and partnership agreements (see IRS Publication 561: Determining the Value of Donated Property).
- Red Flag: IRS is targeting “non-operating” partnerships set up solely for discounting without real management activity.
We frequently see families who create a family LLC or LP structure and transfer 40% of the entity to children over several years. When executed with proper documentation, this can shift millions in appreciation tax-free—but casual, DIY attempts are unlikely to survive audit scrutiny after the new 2026 thresholds hit.
Our estate tax planning services help you structure these advanced moves with airtight compliance for 2025 and beyond.
Strategy #3: Lifetime Gifting and the “Use It or Lose It” Window
As we approach the scheduled drop of the federal exemption in 2026, California real estate holders can use today’s $13.61M/p $27.22M/couple limit for lifetime gifts that escape future estate taxation. Consider this scenario:
- George and Linda own $18M in coastal properties + $6M brokerage account
- They use today’s limit to gift $13.6M of rental real estate into trusts for their children in 2025
- When exemption halves in 2026, their remaining estate at death will likely face less than $350,000 in estate tax (vs. a $5.5M hit if they delayed all planning).
But here’s the catch: Large gifts must be reported on IRS Form 709, and valuation errors or late filings can void the tax break. The IRS has warned it will not allow retroactive “top-off” gifts after the exemption contracts. File and document properly, with current appraisals and irrevocable trust execution, before year-end.
What’s the Simplest Way to Move Wealth Tax-Free in 2025?
If your estate is above $10M and most of it is California real estate, the “big three” for this year are:
- Direct lifetime gifts up to today’s limit—filed on Form 709
- Gifting minority interests (in a properly run partnership or LLC)
- “Freeze” strategies—transferring assets to a trust that captures future appreciation outside your estate
Any move requires bulletproof legal, accounting, and appraisal documentation—especially before 2026. See IRS Gift Tax guidance for reporting requirements.
KDA Case Study: Real Estate Investor Family Avoids $6.9M in Estate Tax
Persona: Multi-generational California real estate investor, family office structure; assets: $27M (residential & commercial CA property portfolio)
Problem: Portfolio held in single names and family joint tenancy, with all wealth set to pass as “probate estate”—triggering full 2026 federal estate tax. Neither the husband, wife, nor their children had any trusts or gifting plan. Risk: $7.2M estate tax in 2026, assets forced into rapid sale at discount, devastating family control and income continuity.
KDA Solution: Re-architected holdings into a combination of properly funded dynasty trusts, minority interest transfers via FLP, and leveraged grantor trusts, all executed in 2025 before the exemption drop. Navigated complex property appraisals, managed IRS audit exposure, and connected legal/accounting experts. Result: $6.9M estate tax eliminated, heirs retain full control, and no forced sale. Cost: $24K in advisory/legal, 287x first-year ROI.
Red Flag Alert: Most Heirs Botch the Step-Up and Title Process
Every year, KDA reviews dozens of California estates where heirs lose six-figures to double tax, probate fees, or IRS challenges—just from failing to update title and basis on inherited properties.
- Step-up basis isn’t properly documented at death, IRS challenges the new value, and capital gains snowball years later.
- Legal title remains in deceased’s name past California’s 40-day rule, spilling property into probate and triggering public auction risks.
- Out-of-state trusts or generic online planning forms miss key California compliance nuances (like reassessment under Prop 13).
Double-check every property’s title, maintain current appraisals, and ensure all trust/partnership docs are up-to-date. See IRS step-up basis guidance for technical rules.
What If You’re a New Investor or Under $10M?
Even if you’re under the looming estate tax thresholds, the right trust or gifting strategy offers crucial advantages:
- Avoids California probate (often $200K+ in fees for $3M property portfolio)
- Protects rental income from creditors
- Maintains Prop 13 status for low property tax base (with correct family transfer structures)
And every investor—regardless of net worth—should be prepared for legislative shifts. Sacramento is discussing new state-level “wealth transfer” taxes for 2026 and beyond. Early action could shield your family from these future encroachments on intergenerational wealth.
Frequently Asked Questions
Is there an estate tax in California for 2025?
No, there is no state estate tax in California for the 2025 tax year. However, federal estate tax applies and the exemption is scheduled to drop sharply in 2026.
How does the federal estate tax exemption change impact California property owners?
If your net worth (including property value) exceeds the exemption—currently $13.61M per person—it’s at risk for 40% federal estate tax after 2026. Gifting and trust strategies must be in place before the exemption falls.
What is the step-up in basis, and why is it important?
The step-up in basis is a reset of property value at date of death for capital gains purposes. If not documented within 6 months on a proper appraisal and IRS Form 706, heirs could face capital gains on the entire appreciation.
How do I avoid probate on California real estate?
By titling property in a properly executed trust or family partnership, you prevent public sale and speed transfer to heirs. Probate in California is costly and public—avoidance is key for any property owner.
Can I give more than $18K/year to my kids without tax?
Yes, but only through proper use of the lifetime exemption and by filing Form 709. Consult a CPA to ensure compliance and maximize your transfer free of tax.
Book Your Estate Tax Strategy Session
If your California properties and investments put you near or over the $10M threshold, don’t wait for the 2026 cliff. Book a private strategy session with our estate tax team. We’ll review your holdings, map powerful gifting and trust structures, and give you an action plan most advisors miss. Click here to schedule your personalized estate planning consultation now.
