Surviving Spouse Step-Up in Basis: 100% or Half Reset

Margaret Ellison, 68, is a widow in San Diego, California. Her husband Robert died in March. They jointly owned a $1,000,000 taxable brokerage account — mostly an S&P 500 index fund and a long-held block of tech stock — with a combined cost basis of $300,000. That is $700,000 of unrealized long-term capital gain. If Margaret had sold the day before Robert died, the federal tax would have been roughly $166,600 (the 20% top long-term rate plus the 3.8% net investment income tax, totaling 23.8%, on the gain above the brackets). Because Robert died a California resident, IRC §1014(b)(6) reset the entire account — both halves — to its date-of-death fair market value of $1,000,000. Margaret’s new basis is $1,000,000. She can sell the whole account today and owe essentially nothing.

Now move Margaret to Columbus, Ohio — a common-law state. Same account, same $300,000 basis, same death. Ohio gives her only a half step-up: Robert’s 50% gets reset, her 50% does not. Her new basis is $650,000 (her original $150,000 half plus Robert’s stepped-up $500,000 half). Selling the full account now realizes $350,000 of gain and a tax bill of roughly $83,300. Same family, same money, same loss — an $83,300 difference driven entirely by which side of a state line they happened to live on.

The answer first: how much step-up you get depends on your state

When a spouse dies, capital assets they owned receive a basis adjustment to date-of-death fair market value under IRC §1014. This is one of the largest tax breaks in the code: it erases the income tax on a lifetime of appreciation. The only question that matters for a surviving spouse is how much of a jointly held asset gets that reset.

• Community-property states (9): Under IRC §1014(b)(6), 100% of jointly held community property is stepped up at the first spouse’s death — both the decedent’s half and the survivor’s half. This is the “double step-up.”
• Common-law / separate-property states (41): Only the deceased spouse’s titled share — typically 50% of a jointly owned asset — is stepped up. The survivor’s half keeps its original basis.

The nine community-property states are California, Arizona, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin. If your spouse died a resident of one of these states and the assets were community property, you have a one-time chance to sell appreciated holdings at close to zero tax. If they died anywhere else, half the built-in gain survives the death and is still yours to pay.

Full step-up vs half step-up: the side-by-side

The 23.8% figure is the worst-case federal rate: the 20% top long-term capital-gains bracket (which starts above $533,400 of taxable income for a single filer in 2026 — the bracket a high-income widow may land in) plus the 3.8% net investment income tax under IRC §1411 on modified AGI over $200,000 single. A survivor with more modest income would pay 15% LTCG instead of 20%, but the structure of the decision is identical: a full step-up makes the gain vanish; a half step-up leaves half of it taxable.

Why community property gets the double step-up

The mechanics live in IRC §1014(b)(6). The statute treats both halves of community property — the deceased spouse’s interest and the surviving spouse’s interest — as having been acquired from the decedent. Because anything acquired from a decedent steps up to date-of-death FMV under §1014(a), the survivor’s half rides along for the full reset even though that spouse is still alive.

In a common-law state there is no such fiction. The surviving spouse’s half was acquired by purchase, not from the decedent, so it keeps its carryover basis. Only the decedent’s 50% — the part that actually passes at death — is stepped up. The result is the half step-up: a $300,000-basis account that is worth $1,000,000 lands at a $650,000 new basis, not $1,000,000.

What the step-up does NOT cover

The step-up reaches capital assets — taxable brokerage holdings, real estate, a closely held business, collectibles. It does not reach retirement accounts. A 401(k), a traditional IRA, or a non-qualified annuity inherited from a spouse is income in respect of a decedent (IRD) and gets no step-up under §1014(b)/(c). Distributions from an inherited traditional IRA are taxed as ordinary income to the survivor exactly as they would have been to the decedent. Do not assume the death reset applies to the whole estate — sort assets into “capital, stepped up” versus “IRD, not stepped up” before you make any sell decision.

The decision: sell now or hold?

The step-up itself is permanent — the new basis doesn’t expire. What is fleeting is the near-tax-free selling window. Only the gain that accrued before the date of death is erased. Every dollar the asset appreciates after the death is new, fully taxable gain. So the closer you sell to the date of death, the cleaner the exit.

For Margaret in California, this is the moment to rebalance out of a concentrated, low-basis position. Robert’s tech-stock block represented 40% of the account and a serious concentration risk. Pre-death, selling it would have triggered six figures of tax — a reason it never got trimmed. Post-death, with basis reset to FMV, she can diversify the entire $1,000,000 into a balanced portfolio at essentially zero capital-gains cost. The estate-planning problem (concentration) and the tax problem (embedded gain) dissolve in the same transaction.

Here is the framework for the sell-vs-hold call:

1. Confirm your step-up percentage. Community-property state and community-property asset → 100%. Common-law state → 50% on jointly held assets. This single fact sets the size of the opportunity.
2. Get a date-of-death valuation in writing. For publicly traded securities, basis is the mean of the high and low trading price on the date of death (or the alternate valuation date six months later, if the estate elects it under IRC §2032). Document it — your custodian may not adjust basis automatically.
3. Sell the appreciated, concentrated positions first. The biggest pre-death gain is where the step-up does the most work. Diversify near the date of death before markets add new taxable appreciation.
4. Leave IRD assets alone for this analysis. Inherited IRAs and 401(k)s follow their own rules (spousal rollover, the 10-year rule for non-spouse beneficiaries) — the step-up decision does not apply to them.

What most people miss

Three traps quietly cost surviving spouses money:

• Assuming the custodian resets your basis. Brokerages are required to track basis on covered securities, but they frequently do not apply the death step-up automatically — especially the full community-property reset, which the firm has no way to know applies. If you sell and the 1099-B still shows the old $300,000 basis, the IRS sees a $700,000 gain. You must adjust basis on Form 8949 with code “B” and a written date-of-death valuation to support it.
• Letting the window close. Many widows freeze for a year after a death — understandably. But a portfolio that climbs 15% in that year converts $150,000 of would-be-tax-free gain into fully taxable post-death appreciation. The decision to diversify is most valuable in the first few months, exactly when it feels hardest to make.
• Holding a low-basis position to “get the second step-up.” In a community-property state the surviving spouse’s now-stepped-up assets will step up again at the second death. That is real, but it is a bet that you won’t need the money and can tolerate concentration risk for years or decades. The second step-up is a legacy benefit; it does nothing for the survivor who needs to diversify or spend. Do not let a future step-up justify carrying a dangerous single-stock position today.

Common-law states: the opt-in escape hatch

If you live in a common-law state, the half step-up is not always the final word. A handful of separate-property states let married couples elect into community-property treatment through a community-property trust — including Alaska, Tennessee, South Dakota, Kentucky, and Florida. Assets retitled into a qualifying trust are treated as community property for §1014(b)(6) purposes, restoring the full 100% step-up at the first death.

This is a planning move for couples who are both still alive — it cannot be done retroactively after a death. But for a couple in Ohio holding a $1,000,000 low-basis account, retitling into an Alaska community-property trust could be the difference between a $1,000,000 and a $650,000 basis for the eventual survivor. The example earlier — the $83,300 Ohio tax bill — is exactly what that planning would have erased.

State income tax on the gain you do realize

Federal capital-gains treatment is only half the bill. Most states tax capital gains as ordinary income with no preferential rate. So in a half-step-up state, the survivor pays state tax on top of the federal 15–23.8% — California at up to 13.3%, New York up to 10.9%, New Jersey 10.75%. The nine no-income-tax states (including community-property members Texas, Washington, Nevada, and Florida for the trust route) add nothing. That is a second, often overlooked, advantage of the community-property states: several of them combine the full step-up with zero state tax on whatever post-death gain you do eventually realize.

The decision lever

The single fact that controls this decision is your step-up percentage, and it was largely set the day your spouse died, by the state they died in. If you are a surviving spouse in a community-property state (CA, AZ, ID, LA, NV, NM, TX, WA, WI) holding appreciated community property, the move is to get a written date-of-death valuation and sell or diversify your concentrated, low-basis positions now — while the gain is reset and before new post-death appreciation rebuilds a taxable embedded gain. On a $700,000 pre-death gain, acting inside the window is worth up to $166,600 in federal tax alone. If you are in a common-law state, run the half-step-up math before you sell anything: you may want to hold your own half for the second step-up while selling the stepped-up half — and if both spouses are still living, a community-property trust is the lever that converts the half step-up into a full one before it’s too late.