Community Property Step-Up in Basis: The Double Step-Up Advisors Must Know

A surviving spouse in Texas calls to ask whether they should sell the joint portfolio. Their advisor in New York runs the tax projection using the standard 50% step-up assumption — and overestimates the capital gains bill by hundreds of thousands of dollars.

The mistake happens because most financial advisors default to common law property rules, where only the decedent's half of jointly held assets receives a step-up in basis at death. In community property states, both halves step up. It is one of the most consequential distinctions in estate tax planning, and getting it wrong can cost a surviving spouse real money or, worse, cause them to hold assets they would otherwise sell.

How Basis Step-Up Works in Common Law States

In the 41 common law property states (plus Washington, D.C.), jointly held assets receive a partial step-up. Under IRC Section 1014, only the decedent's ownership interest is adjusted to fair market value on the date of death. The surviving spouse's half retains its original cost basis.

If a couple purchased stock for $100,000 that grew to $500,000 at the first spouse's death, the surviving spouse's new adjusted basis is $300,000 — half at the original $50,000 cost basis plus half stepped up to $250,000. Selling the portfolio immediately after death triggers tax on $200,000 of embedded capital gains.

That embedded gain shapes every recommendation the advisor makes about the surviving spouse's portfolio. It influences whether to sell, hold, harvest losses elsewhere, or wait for further appreciation. It is a planning constraint that colors the entire post-death financial picture.

The Community Property Double Step-Up

In the nine community property states — Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin — IRC Section 1014(b)(6) provides a full step-up for both the decedent's and the surviving spouse's halves of community property assets.

Same scenario: $100,000 original basis, $500,000 fair market value at death. In a community property state, the surviving spouse's new adjusted basis is the full $500,000. Selling immediately produces no capital gain from the appreciation before death.

The double step-up eliminates the embedded gain entirely. The surviving spouse can liquidate, rebalance, or reallocate without any tax drag from the original purchase price. For high-net-worth clients with concentrated positions or decades of unrealized gains, this distinction can save six or seven figures in capital gains taxes.

Which Assets Qualify

Not every asset in a community property state automatically qualifies for the double step-up. The asset must actually be community property — meaning it was acquired during the marriage using community funds or community effort.

Assets that typically qualify:

• Brokerage accounts funded with earnings during the marriage
• Real estate purchased during the marriage with community funds
• Business interests acquired during the marriage

Assets that typically do not qualify:

• Property owned before the marriage (separate property)
• Inheritances received by one spouse (separate property in all community property states)
• Gifts received by one spouse
• Assets covered by a valid prenuptial or postnuptial agreement designating them as separate property

The critical question is how the asset was titled and funded, not simply which state the couple lives in. Commingling — mixing separate and community funds in a single account — creates tracing problems that can require forensic analysis to resolve. Advisors should flag commingling risk during the estate transition and defer the characterization question to the estate attorney or CPA.

Opt-In Community Property for Non-CP States

Alaska, Florida, Tennessee, South Dakota, and Kentucky have statutory community-property trusts or comparable arrangements for property transferred to a qualifying trust. A properly structured arrangement may change the assets' state-law characterization, but do not assume it guarantees the federal basis adjustment under IRC Section 1014(b)(6).

The planning question is significant: a couple in Florida with a $2 million portfolio carrying $1.5 million in unrealized gains should not assume that transferring assets into an Alaska community property trust will provide a full step-up on the entire portfolio. The estate attorney and tax professional should confirm the federal treatment before any transfer.

These opt-in arrangements must be established while both spouses are alive and competent. They cannot be created retroactively after a death. Advisors working with high-net-worth clients in common law states should be aware of this planning tool, even though the execution involves trust attorneys and careful documentation.

What Advisors Get Wrong

Applying common law rules to community property clients. This is the most common error. An advisor whose practice spans multiple states, or who serves clients who relocated from a common law state to a community property state (or vice versa), must check the state of domicile and the characterization of each asset before running tax projections.

Ignoring quasi-community property rules. California and several other states have quasi-community property statutes that treat certain assets acquired in common law states as community property if the couple later moves to a community property state. The rules vary, and the implications for basis step-up depend on the specific statute.

Failing to document community property status. The double step-up is only available if the assets are properly characterized as community property. Without documentation — account agreements, community property agreements, or trust instruments — the IRS may challenge the characterization, and the surviving spouse could lose the benefit entirely.

Getting the basis calculation right is one of the most time-sensitive tasks in the post-death workflow. The Financial Advisor's Deceased Client Guide includes a date-of-death valuation worksheet that walks through community property vs. common law calculations step by step, ensuring no tax benefit is missed during the estate transition.