California Retirement Tax Guide: Prop 19, Mello-Roos, Medi-Cal, and the 13.3% Trap

What California taxes, and what it doesn't

California's retirement tax treatment is more favorable than its overall reputation suggests, with several major exceptions:

California does NOT tax:

• Social Security benefits (federal taxation still applies)
• Railroad retirement benefits
• VA disability benefits
• Inheritances or estates (no state inheritance or estate tax)

California DOES tax (at up to 13.3% top bracket):

• Traditional IRA and 401(k) withdrawals: fully taxed as ordinary income
• Pension income: fully taxed
• Roth conversions: fully taxed in the year of conversion
• Capital gains: taxed as ordinary income (NO preferential rate, unlike federal)
• Qualified dividends: same as capital gains, no preferential rate
• Rental income: fully taxed

The headline rate for high-income CA retirees is 13.3% on the top marginal bracket (taxable income above $1,485,906 MFJ in the 2025 tax year). The more practical number for most retirees is 9.3% (the 2025 bracket from $145,448 to $742,958 MFJ taxable income). California's 13.3% top rate is the highest state income tax rate in the country (FTB 2025 tax rate schedules).

Prop 19: what it changed for inherited property

Proposition 19 passed in November 2020 and took effect February 16, 2021. It fundamentally changed how California treats parent-to-child property transfers at death.

Before Prop 19 (Prop 58 era)

Parents could transfer their primary residence to children with the property tax assessment fully preserved. Up to $1 million of any other California property (rentals, vacation homes) could also transfer with assessment preserved. This created a massive intergenerational tax advantage: kids inherited the property along with the parents' decades-old low property tax basis.

After Prop 19

• Primary residence: Children can still inherit the assessment IF they make it their own primary residence within one year of the transfer. There's also a $1 million inflation-adjusted exclusion above the current assessed value (so if the home has appreciated more than $1M since the parents' assessment, the excess gets reassessed).
• Rental property, vacation homes, commercial property: Full reassessment to current market value. The $1M exclusion is gone for these. A rental that's been in the family at a 1985 assessment will reassess at 2026 market value the moment it transfers to the kids.

For California retirees with rental real estate they intended to leave to children, Prop 19 dramatically changed the math. A property purchased in 1990 for $300K and now worth $1.5M would have transferred to children at the original $300K-ish assessed value (with normal Prop 13 inflation adjustments). Post-Prop 19, it reassesses at $1.5M, typically tripling or quadrupling the annual property tax for the children.

What to do about Prop 19 if you own rental property

Three categories of response:

1. Hold to death (still works for primary residence + appreciation step-up)

The federal step-up basis in basis at death still works: your heirs get a clean cost basis at fair market value. Combined with the primary-residence Prop 19 exception (if they'll live there), this can still be powerful. But for non-primary residences, the property tax reassessment is the new cost.

2. Sell and spread the gain with an installment sale (Section 453)

If the buyer pays you over several years instead of all at closing, federal law generally lets you report the gain as the payments come in (IRS Publication 537). That can keep each year's income under a higher bracket or an IRMAA line. The trade-offs are real: depreciation recapture is taxed in the year of sale no matter when you are paid, the interest you receive is ordinary income, California taxes the gain as ordinary income too, and you are relying on the buyer, or whoever takes over the payments, to pay on time. It is one option to compare with selling outright, not a way to make the tax go away.

3. Refinance, hold, let kids deal with it

Some retirees facing Prop 19 reassessment exposure refinance the property to pull cash out (using the cash for current spending or other planning costs) and let the kids face the reassessment. This is a liquidity strategy rather than a tax strategy. It accepts that Prop 19 will hurt and adjusts accordingly.

For California retirees with multi-million-dollar rental portfolios, Prop 19 is the single biggest estate-planning shift in the last 30 years. It deserves a focused conversation with a tax professional who actually understands the CA rules.

Medi-Cal: the asset test is back in 2026

Medi-Cal is California's Medicaid program. For seniors needing long-term care, Medi-Cal eligibility has long required being below an asset limit as well as an income limit, or doing Medicaid planning (gifting, irrevocable trusts, etc.) to qualify. California raised that limit to $130,000 for one person in 2022, then removed the asset test entirely on January 1, 2024.

As of January 1, 2026, the asset test is back. The 2025 state budget (AB 116) set the limit at $130,000 for one person plus $65,000 for each additional household member ($195,000 for a couple). It applies to the programs most retirees use: Aged, Blind and Disabled Medi-Cal, Share of Cost Medi-Cal, long-term care, and the Medicare Savings Programs. One home you live in is still exempt; a second home counts. People already enrolled are checked at their first annual renewal in 2026.

The limit is scheduled to drop sharply. The Department of Health Care Services says the $130,000 limit applies through June 30, 2027. Starting July 1, 2027 it is $21,000 for one person and $31,000 for two (DHCS, Medi-Cal asset limits, read October 10, 2026). Anyone counting on Medi-Cal for long-term care should plan around the lower number.

What this means for planning:

• Savings count again: A widow with $400K in a bank or brokerage account is well over the $130,000 limit and would have to spend down before Medi-Cal long-term care pays. The home she lives in is still exempt.
• Estate recovery still applies: California can still attempt estate recovery against the recipient's estate after death, though enforcement and exemptions vary.
• Both levers matter: Medi-Cal planning now has to look at countable assets and income together. The rules changed twice in three years, so check the current limits with the Department of Health Care Services or an elder law attorney before acting.

For California retirees worried about long-term care costs, the two-year window when savings did not count has closed. Medi-Cal is still a backstop, but only once countable assets are under the limit.

Mello-Roos and the property tax reality

California property tax is governed primarily by Prop 13 (1978), which caps annual increases at 2% and reassesses at sale or major improvement. This is one of the most favorable property tax environments in the country for long-time owners.

The "Mello-Roos" wrinkle applies to certain newer developments (typically post-1982 in most of the state, post-1990s in many SoCal neighborhoods). Mello-Roos refers to Community Facilities Districts that levy additional special taxes on top of the base 1% Prop 13 rate, often 0.5-2% additional, sometimes more.

For retirees:

• If you bought your primary residence in 1985 in an older neighborhood, your property tax bill is likely tiny. Prop 13 has done you decades of favor.
• If you're considering downsizing within California: the new home will reassess at market value AND may carry Mello-Roos special tax. Your property tax bill can easily 5x even if you "downsize" by square footage. The Prop 19 portability rules (parent's assessment transferable to a smaller home of similar value, with conditions) help in some cases. Verify with your county.
• If you're considering selling appreciated CA real estate: the capital gain (taxed at CA's ordinary rate, no preferential treatment) plus the 20% federal rate plus the 3.8% net investment income tax can reach about 37% of the gain at the top rates. Run the numbers with a tax professional before you list the property.

The Roth conversion case in California

California taxes Roth conversions at the same ordinary income rates as IRA withdrawals, up to 13.3%. This makes the conversion math marginally less favorable in California than in no-state-tax states like Texas, Florida, or Nevada.

But the case is still overwhelmingly positive for most California retirees, because:

• The state will tax the IRA eventually, either when you take RMDs or when you convert. The decision is when, not whether.
• Pre-conversion (in your 60s, before SS, before RMDs) often happens in lower CA brackets than post-RMD income would.
• If you plan to move to a state with no income tax (Nevada, Florida, Texas and others), the timing matters. California taxes a conversion you do while you are a resident. A conversion done after you have truly changed your domicile is not taxed by California, and federal law (4 U.S.C. 114) also bars a state from taxing a former resident's later retirement distributions. So a conversion is usually cheaper after the move, not before. Residency is a facts-and-circumstances test and the Franchise Tax Board does audit moves (FTB Publication 1031).
• The federal case for conversion is unchanged regardless of state. CA tax adds friction but rarely changes the directional conclusion.

If a move is part of your plan, talk to a tax professional well before the move date. The order of the move and the conversion can change the state tax bill by thousands of dollars.

Hans Goldstein, EA

Founder & Executive Director · Retirement Literacy Foundation, a 501(c)(3) non-profit
Admitted to practice before the IRS

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