Step-Up Basis: Community Property Double-Step-Up Strategy

The step-up in basis is the single largest tax benefit most American families will ever receive — and most do not know it exists until they need it. Under IRC §1014(a), when a person dies, the cost basis of their capital assets resets to fair market value on the date of death. Every dollar of unrealized capital gain accumulated during the decedent's lifetime is eliminated. The heir inherits the asset at its current value, not its original purchase price, and can sell immediately with zero capital gains tax.

For married couples in the 9 community property states, this benefit doubles. IRC §1014(b)(6) provides that when one spouse dies, both halves of community property — the decedent's half and the surviving spouse's half — receive a step-up in basis. The surviving spouse's half, which they never transferred and never inherited, gets a new basis anyway. This is the community property double step-up, and it is worth understanding in detail.

How the standard step-up in basis works: IRC §1014(a)

The general rule is straightforward. Under IRC §1014(a)(1), the basis of property acquired from a decedent is the fair market value of the property at the date of death (or the alternate valuation date under IRC §2032, if elected by the executor). This applies to any property "included in the gross estate" of the decedent for federal estate tax purposes under IRC §2031.

What qualifies: stocks, bonds, mutual funds, ETFs, real estate, business interests, collectibles, and any other capital asset held outside of a tax-deferred retirement account. What does not qualify: assets inside IRAs, 401(k)s, 403(b)s, and other qualified plans. Those are governed by IRC §408, §401(a)(9), and related provisions — distributions are taxed under their own rules, and the step-up does not apply.

The step-up also does not apply to income in respect of a decedent (IRD) under IRC §691. IRD includes items like unpaid salary, deferred compensation, installment sale receivables, and — critically — distributions from traditional retirement accounts. These items retain their character as ordinary income to the recipient, regardless of the step-up that applies to capital assets.

Common-law states: the single step-up on joint property

In the 41 common-law states (plus the District of Columbia), married couples who hold property as joint tenants with right of survivorship or as tenants by the entirety receive a step-up on only the decedent's half of the property. The surviving spouse's half retains its original cost basis.

Example: Tom and Linda, married, living in New York, bought $400,000 of stock in 2005 as joint tenants. The stock is worth $2,000,000 when Tom dies in 2026. Each spouse is deemed to own 50%, so Tom's half ($1,000,000) receives a step-up from his $200,000 basis to $1,000,000. Linda's half retains her original $200,000 basis. If Linda sells the entire position immediately after Tom's death:

• Tom's half: $1,000,000 sale price − $1,000,000 stepped-up basis = $0 gain
• Linda's half: $1,000,000 sale price − $200,000 original basis = $800,000 gain
• Federal tax at 23.8% (20% LTCG + 3.8% NIIT): $190,400

Linda keeps $800,000 in unrealized gains on her half. If she does not sell, those gains continue to grow and will only be eliminated when she dies (her heirs will then get a step-up on her assets). But if she needs to sell — to diversify, fund retirement, or pay expenses — she faces a substantial tax bill.

Community property states: the double step-up under IRC §1014(b)(6)

In the 9 community property states — Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin — the rules change dramatically. Under IRC §1014(b)(6), property that is "community property" of the decedent and the surviving spouse receives a full step-up in basis on both halves when either spouse dies. This is not limited to the decedent's half. The surviving spouse's half — property they still own — also gets the step-up.

Same example, different state: Tom and Linda live in California. They bought the same $400,000 of stock in 2005 with community funds. The stock is worth $2,000,000 when Tom dies in 2026. Because it is community property, both halves receive a step-up:

• Tom's half: $1,000,000 stepped up to $1,000,000 = $0 gain
• Linda's half: $1,000,000 stepped up to $1,000,000 = $0 gain
• Federal tax if Linda sells everything immediately: $0

The difference: $190,400 in federal capital gains tax eliminated, solely because the couple lived in a community property state. No trust required. No special election. The double step-up is automatic for assets properly classified as community property.

A worked example with realistic numbers

Maria and David, married 30 years, live in Texas. Over their marriage, they built a taxable brokerage portfolio using community funds:

• Total portfolio value at David's death in 2026: $3,200,000
• Total cost basis (original purchase prices): $600,000
• Embedded unrealized capital gain: $2,600,000

If they lived in a common-law state (single step-up)

• David's half ($1,600,000) receives a step-up: new basis = $1,600,000
• Maria's half ($1,600,000) retains original basis: $300,000
• Maria's embedded gain on her half: $1,300,000
• If Maria sells her half: federal tax at 23.8% = $309,400

In Texas (community property double step-up)

• David's half ($1,600,000) receives a step-up: new basis = $1,600,000
• Maria's half ($1,600,000) receives a step-up: new basis = $1,600,000
• Maria's embedded gain on her half: $0
• If Maria sells her half: federal tax = $0
• Tax savings from the double step-up: $309,400

If Maria sells the entire $3,200,000 portfolio immediately after David's death in Texas, she owes $0 in capital gains tax. In a common-law state, she would owe $309,400 on her half alone. Over a 30-year marriage with significant appreciation, the double step-up routinely saves six figures.

What qualifies as community property: the classification rules

The double step-up under IRC §1014(b)(6) applies only to assets that are actually community property under state law. Each community property state has its own classification rules, but the general framework is consistent:

• Community property: assets acquired by either spouse during the marriage using community funds (earnings from employment, investment income from community assets). This is the default classification in all 9 states.
• Separate property: assets owned by either spouse before the marriage, plus assets received by gift or inheritance during the marriage. Separate property does not receive the double step-up — only the decedent's share gets the standard step-up under IRC §1014(a).
• Commingled property: when separate property is mixed with community property (e.g., depositing an inheritance into a joint investment account), tracing rules determine what portion remains separate. If tracing fails, the entire asset may be reclassified as community property — which actually benefits the double step-up analysis.

Critical planning point: keep separate property separate. If you inherit $500,000 from a parent and invest it in a dedicated brokerage account titled in your name alone, it remains your separate property. If you deposit it into the joint brokerage account you share with your spouse, you may have commingled it into community property. In most situations commingling is unintentional — but for step-up planning, it may be advantageous if you are the healthier spouse and expect your partner to predecease you.

The federal estate tax interaction

The step-up in basis and the federal estate tax are two sides of the same coin. Under IRC §2031, assets included in the gross estate are subject to estate tax — but they also qualify for the basis step-up under IRC §1014. In 2026, the federal estate tax exemption is $13.61 million per person ($27.22 million for a married couple using portability). For estates below these thresholds, the step-up is a pure benefit with no offsetting estate tax.

However, the TCJA exemption is scheduled to sunset after 2025. If Congress does not act, the exemption drops to approximately $7 million per person (indexed for inflation from the pre-TCJA $5.49 million baseline). For a married couple in a community property state with $10 million in community assets, the double step-up eliminates all capital gains — but the estate may now owe estate tax on the amount exceeding the reduced exemption.

The interaction matters for planning: the double step-up saves capital gains tax (up to 23.8%), while the estate tax rate is 40%. For very large estates that exceed the exemption, the estate tax cost may outweigh the capital gains savings. But for most American families — those with estates between $1 million and $13 million — the step-up is an unambiguous benefit, and the double step-up in community property states doubles it.

State-level estate and inheritance taxes

Twelve states and the District of Columbia impose their own estate taxes, often with exemptions far below the federal level. Among the community property states, Washington is the notable one — it imposes a state estate tax with a $2.193 million exemption and rates from 10% to 20%. A Washington couple with $4 million in community property gets the full double step-up on capital gains but may owe Washington estate tax on the amount exceeding $2.193 million.

The other 8 community property states do not impose a state estate tax: Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, and Wisconsin have no state estate or inheritance tax. For residents of these states, the double step-up is entirely beneficial — no state-level clawback.

For comparison, common-law states with aggressive estate taxes include Massachusetts (exemption: $1 million), Oregon (exemption: $1 million), Minnesota (exemption: $3 million), and New York (exemption: $6.94 million with a cliff — if your estate exceeds the exemption by more than 5%, the entire estate is taxable, not just the excess).

Retirement accounts: where the step-up does not help

One of the most common misunderstandings in estate planning is the belief that inherited retirement accounts receive a step-up in basis. They do not. Traditional IRA and 401(k) distributions are income in respect of a decedent under IRC §691 — they are taxed as ordinary income to the beneficiary, regardless of when the original owner made contributions or what the account was worth at death.

Under the SECURE Act, most non-spouse beneficiaries must distribute the entire inherited retirement account within 10 years of the owner's death under IRC §401(a)(9)(H). This creates a significant income tax burden that the step-up in basis does nothing to address. For a married couple with $2 million in a taxable brokerage (community property, double step-up available) and $2 million in a traditional IRA (no step-up, 10-year distribution rule), the estate planning strategies are completely different.

Planning implication for community property couples: maximize the proportion of wealth held in taxable accounts rather than tax-deferred accounts when the double step-up is available. A dollar of appreciated stock in a taxable community property account gets a full double step-up — basis resets to fair market value, all gains erased. That same dollar in a traditional IRA will be taxed as ordinary income to the heir at rates up to 37% (or 39.6% if the TCJA sunsets). For high-net-worth couples in community property states, this may favor Roth conversions during life — moving assets out of traditional IRAs (which get no step-up benefit) and into Roth IRAs (tax-free distributions) or taxable accounts (double step-up).

The Alaska community property trust: an opt-in path for common-law state residents

Alaska is technically a separate-property state by default, but it enacted the Alaska Community Property Act in 1998, allowing married couples to elect community property treatment for specific assets by executing a community property agreement or transferring assets into an Alaska community property trust. Several estate planners have used this vehicle to obtain the double step-up for couples living in common-law states.

The mechanics: the couple creates an Alaska community property trust with an Alaska-based trustee (a bank or trust company with a physical presence in Alaska). They transfer appreciated assets into the trust. Under Alaska law, those assets become community property. When one spouse dies, the argument is that IRC §1014(b)(6) applies — both halves receive the step-up.

The risk: the IRS has not issued definitive guidance confirming that IRC §1014(b)(6) applies to Alaska community property trust assets held by non-Alaska residents. The statute references property that "is community property under the applicable community property law," which should include Alaska's statute. But the lack of a published revenue ruling or court decision leaves some uncertainty. The strategy is widely used by estate planners, and several private letter rulings (which apply only to the taxpayer who requested them) have been favorable. But it is not risk-free.

Tennessee and South Dakota also permit community property trusts under similar statutes. The same IRS uncertainty applies.

Edge cases and planning traps

Trap 1: Converting community property to separate property by mistake

In community property states, couples sometimes sign transmutation agreements — documents that reclassify community property as one spouse's separate property. This is common in divorce planning, prenuptial agreements, and business structuring. If appreciated community property is transmuted to separate property of the surviving spouse, it loses the double step-up. The surviving spouse's half retains its original basis, and only the decedent's half (if any interest remains) gets the step-up under §1014(a).

Trap 2: Moving from a community property state to a common-law state

If a couple acquires assets as community property in California and then moves to New York, the character of those assets is generally preserved under the "tracing" doctrine — they remain community property. However, the practical burden of proving community property classification years later falls on the surviving spouse or executor. Without clear records (account statements, purchase documentation, a community property agreement), the IRS could challenge the double step-up claim. If you move from a community property state, consider creating a formal community property agreement that documents which assets are community property before you relocate.

Trap 3: The step-down risk

IRC §1014 provides a step-up or step-down to fair market value. If community property has declined in value since purchase, the double step-up becomes a double step-down — both halves reset to the lower current value. If the couple holds a stock purchased for $500,000 that is now worth $200,000, both halves step down to $200,000 at death. The $300,000 loss is permanently lost — it cannot be claimed by anyone. Before a seriously ill spouse dies, consider selling declined assets to realize the capital loss while it is still available.

Trap 4: Gifting appreciated assets before death

Under IRC §1015, gifts of appreciated property during life carry over the donor's basis — no step-up. If a parent gifts $500,000 of stock (with a $100,000 basis) to a child before death, the child inherits the $100,000 basis. If the parent had held the stock until death, the child would have received a stepped-up basis of $500,000. This "gift vs. bequest" trap costs families billions in unnecessary taxes every year. For community property couples, the penalty is doubled: gifting community property before death eliminates both halves of the potential double step-up.

SECURE Act 2.0 and the step-up: retirement accounts vs. taxable accounts

SECURE 2.0, enacted in December 2022, reinforced the 10-year distribution rule for inherited retirement accounts and made several changes that amplify the advantage of holding wealth in step-up-eligible taxable accounts rather than tax-deferred accounts:

• Roth 401(k) RMDs eliminated: starting in 2024, Roth 401(k) participants no longer face lifetime RMDs, meaning more Roth assets remain at death. While Roth distributions are tax-free, the assets do not get a basis step-up — they are simply excluded from income under IRC §408A(d)(1).
• Increased catch-up contributions for ages 60-63: SECURE 2.0 allows higher catch-up contributions ($10,000, indexed) for workers aged 60-63 starting in 2025, but these must be Roth contributions for workers earning over $145,000. This pushes more assets into Roth accounts rather than taxable accounts.
• 529-to-Roth IRA rollovers: starting in 2024, unused 529 plan funds can be rolled into a Roth IRA for the beneficiary (subject to lifetime limits and holding period requirements). These assets also do not receive a basis step-up.

The strategic takeaway: for community property couples with substantial wealth, the double step-up makes taxable brokerage accounts the most tax-efficient vehicle for assets you intend to leave to heirs. A dollar of appreciated stock in a community property taxable account passes to heirs with zero capital gains tax. A dollar in a traditional IRA passes with ordinary income tax rates of up to 37%. A dollar in a Roth IRA passes tax-free but offers no additional basis benefit. The ordering — taxable (with double step-up) > Roth > traditional — is specific to community property states and reverses the conventional wisdom that prioritizes maxing out tax-deferred accounts.

Key takeaways

• The step-up in basis under IRC §1014(a) resets the cost basis of inherited capital assets to fair market value at death, eliminating all unrealized capital gains accumulated during the decedent's lifetime.
• In the 9 community property states, IRC §1014(b)(6) provides a double step-up: both the decedent's half and the surviving spouse's half of community property receive the basis reset. In common-law states, only the decedent's half is stepped up.
• The double step-up applies only to assets properly classified as community property under state law. Separate property (pre-marriage assets, gifts, inheritances) does not qualify unless commingled.
• Retirement accounts (traditional IRAs, 401(k)s) do not receive any step-up in basis. They are income in respect of a decedent under IRC §691 and are taxed as ordinary income to the beneficiary under the SECURE Act 10-year distribution rule.
• For community property couples, the double step-up may make taxable brokerage accounts more tax-efficient than traditional IRAs for wealth intended to pass to heirs — reversing the conventional account-priority ordering.
• Alaska, Tennessee, and South Dakota offer community property trust elections for non-residents, but the IRS has not issued definitive guidance confirming that IRC §1014(b)(6) applies to these arrangements.
• Watch for planning traps: transmutation agreements, state-to-state moves without documentation, the step-down risk on declined assets, and the gift-vs.-bequest basis difference under IRC §1015 vs. §1014.