Double Step-Up in Basis for Community Property: Assets and Trusts

The double step-up in basis for community property is a federal tax rule that resets the cost basis of an entire community property asset to its fair market value when one spouse dies, not just the deceased spouse’s half. For a surviving spouse, that can erase every dollar of capital gain that built up during the marriage. It applies automatically to couples in nine community property states and can be accessed by election through specialized trusts in five other states.¹

How the Basis Reset Works

When someone inherits property, the IRS generally resets its tax basis to the fair market value on the date of death. If parents bought stock for $10,000 that is worth $200,000 when they die, the heir’s basis becomes $200,000 and the $190,000 of lifetime appreciation escapes capital gains tax.²

Married couples in common law states only get half of that benefit on jointly owned property. Say a couple bought a home for $200,000 and it is worth $1 million when one spouse dies. Only the decedent’s $500,000 half steps up to fair market value. The survivor’s half keeps its original $100,000 basis. Combined basis: $600,000. Selling right away would trigger tax on $400,000 of gain.

Community property is treated differently. Under Section 1014(b)(6) of the Internal Revenue Code, the surviving spouse’s half of community property is treated as if it were also acquired from the decedent, so both halves get the basis adjustment.³ In the same example, the basis in the $1 million home becomes the full $1 million. IRS Publication 551 puts it directly: “When either spouse dies, the total value of the community property, even the part belonging to the surviving spouse, generally becomes the basis of the entire property.”¹

For couples who have held real estate or a stock portfolio for decades, the difference between a full step-up and a half step-up often runs into six figures.

Where the Rule Applies

Nine states follow community property rules: Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin.⁴ In these states, income earned and property acquired during a marriage is presumed to belong equally to both spouses regardless of whose name is on the title. That equal-ownership structure is what triggers the double step-up at death.

Property owned before the marriage or received during the marriage as a gift or inheritance is separate property and does not qualify. The rule is about what the marriage produced, not what each spouse brought in.

Opt-In Community Property Trusts

Couples who live somewhere else can still reach the double step-up through community property trusts authorized in five states: Alaska, Florida, Kentucky, South Dakota, and Tennessee.⁵ These states have enacted statutes classifying assets transferred into a qualifying trust as community property under state law. South Dakota’s statute goes furthest, explicitly declaring that property in its special spousal trust qualifies as community property for purposes of Section 1014(b)(6).⁶

The trust has to be created under the specific state’s statute, signed by both spouses, and administered by at least one qualified trustee (requirements vary). Couples don’t need to live in the state, but at least one trustee generally must be a resident or an entity located there. Alaska also allows a simpler community property agreement as an alternative to a full trust.

One caveat is worth understanding before moving substantial assets: the IRS has not issued a public revenue ruling confirming that opt-in trust property qualifies under Section 1014(b)(6). The statutory argument is strong, since Section 1014(b)(6) refers to property held “under the community property laws of any State,” and these states have enacted laws classifying trust assets as community property. Definitive IRS or judicial guidance is still missing, though.

Which Assets Qualify

The double step-up applies to assets properly classified as community property under state law, as long as at least half the community interest is includable in the decedent’s gross estate for federal estate tax purposes.³ For ordinary married couples that condition is essentially always met, so the practical question is whether the asset is genuinely community property.

Titling Can Break the Benefit

Assets titled as joint tenants with right of survivorship or as tenants in common may not qualify, even in a community property state and even if community funds paid for them. The IRS has ruled that using community funds to buy property titled as tenants in common does not preserve the community property character needed for the double step-up.⁷ Some states presume property held by spouses is community property even when a deed says “joint tenants,” but that presumption is not something to bet a six-figure tax benefit on. Title community property as community property on the deed or account registration.

Assets That Never Get a Step-Up

Certain assets are excluded from any basis adjustment at death, community property or not. These are assets classified as income in respect of a decedent, meaning the income was earned but never taxed during the decedent’s lifetime. The common ones:

Traditional IRAs and 401(k)s. Withdrawals are taxed as ordinary income to the beneficiary.
Deferred compensation and pensions. Payments remain taxable income when received.
Annuities. The gain component is taxed as ordinary income on distribution.

Community property status does not change any of that. The double step-up matters most for assets carrying unrealized capital gains: real estate, taxable brokerage accounts, business interests, and collectibles.

Establishing Community Property Status

If an asset wasn’t acquired during the marriage in a community property state, the couple has to take affirmative steps to give it community property character. The clean method is a transmutation agreement, a written document in which both spouses agree to change property from separate to community. Some states require specific language or formalities.⁷ Standard practice is a written agreement executed before a notary and kept with other estate planning documents.

Commingling separate funds with community funds can also reclassify property, but the outcome depends on whether the separate funds can still be traced, and tracing disputes invite audits and litigation.⁷ Use a written agreement.

Setting the New Basis

The new basis equals the fair market value of the community property at the date of the first spouse’s death.¹ How that value is established depends on the asset. For publicly traded stocks and bonds, the IRS accepts the average of the high and low trading prices on the date of death. Real estate and closely held business interests need a professional appraisal. Residential appraisals typically cost between $300 and $600, though complex or high-value properties run higher. Get it done promptly and keep it with the estate records; if the IRS later questions the claimed basis, a contemporaneous appraisal is the best defense.

The Alternate Valuation Date

If asset values drop after the date of death, an executor can elect to value everything six months later under Section 2032 of the Internal Revenue Code. The election requires filing a federal estate tax return, and the alternate date has to reduce both the total gross estate and the estate tax owed.⁸ It is irrevocable. Anything sold or distributed within the six months is fixed at its value on the date of sale or distribution.

The election locks in the lower value as the new basis for every asset in the estate. The estate saves on estate tax, but the survivor gets a lower basis and potentially larger capital gains later. The tradeoff only matters when the estate actually owes estate tax, which for 2026 means a gross estate above $15 million.⁹

Selling the Home After a Spouse’s Death

The double step-up pairs well with the capital gains exclusion on a primary residence. A single taxpayer can exclude up to $250,000 of gain on a home sale, and a couple filing jointly can exclude $500,000. After a spouse dies, the survivor can still use the $500,000 exclusion if the home is sold within two years of the date of death.¹⁰

Suppose a couple bought a home for $200,000 in a community property state and it is worth $1.2 million when one spouse dies. The double step-up resets the basis to $1.2 million. Selling within two years for $1.5 million produces $300,000 of gain, which the $500,000 exclusion wipes out entirely. In a common law state with only a half step-up, the basis would be $700,000, the gain would be $800,000, and even with the $500,000 exclusion the survivor would owe tax on $300,000.

After the two-year window closes, the survivor’s exclusion drops to $250,000. Timing the sale around that deadline can save tens of thousands of dollars.

When the Rule Hurts

The reset works in both directions. If community property has lost value since purchase, both halves step down at death, and the built-in losses vanish.

Consider a couple who paid $500,000 for stock now worth $200,000 when one spouse dies. In a common law state, only the decedent’s half steps down to $100,000, and the survivor’s half keeps its $250,000 basis, preserving $150,000 in potential losses to offset other gains. In a community property state, both halves step down to fair market value. The survivor’s total basis becomes $200,000, and the $300,000 in paper losses is gone for good.

Two options can preserve the loss if a spouse’s death is anticipated: sell the depreciated asset before death and realize the capital loss (usable against gains or up to $3,000 of ordinary income per year), or execute a transmutation agreement converting the asset from community property to the surviving spouse’s separate property so it falls outside the double-adjustment rule.

Documenting the Basis

Most surviving spouses claiming a double step-up will not need to file a federal estate tax return, because Form 706 is only required for 2026 when the gross estate exceeds $15 million.⁹ The basis still resets to fair market value at death regardless of whether an estate tax return is filed.¹ Keep documentation of fair market value on the date of death anyway, because you will need to support the new basis whenever the asset is eventually sold.

When Form 706 is filed, the executor must also file Form 8971 with the IRS and give each beneficiary a Schedule A reporting the estate-tax value of the property received, which becomes the beneficiary’s basis for income tax purposes.¹¹

1
Internal Revenue Service. Publication 551 – Basis of Assets
2
Internal Revenue Service. Frequently Asked Questions on Gifts and Inheritances
3
Office of the Law Revision Counsel. 26 USC 1014 – Basis of Property Acquired from a Decedent
4
Internal Revenue Service. Publication 555 – Community Property
5
The Florida Legislature. Florida Code 736.1502 – Definitions
6
South Dakota Legislature. Codified Law 55-17 – South Dakota Special Spousal Trust
7
Internal Revenue Service. IRM 25.18.1 Basic Principles of Community Property Law
8
Office of the Law Revision Counsel. 26 USC 2032 – Alternate Valuation
9
Internal Revenue Service. What’s New – Estate and Gift Tax
10
Office of the Law Revision Counsel. 26 USC 121 – Exclusion of Gain from Sale of Principal Residence
11
Internal Revenue Service. Instructions for Form 8971 and Schedule A