Yes. In the nine community property states, the community property step-up in basis resets the entire value of a couple’s shared assets to fair market value when the first spouse dies, not just the deceased spouse’s half. Federal law does this under IRC Section 1014(b)(6), and it can eliminate decades of built-in capital gains on real estate, stock, and business interests in a single moment.1Office of the Law Revision Counsel. 26 USC 1014 – Basis of Property Acquired From a Decedent Couples in common law states get only half that benefit on jointly held property, which is why the community property rule is one of the most valuable quirks in the federal tax code.
How the Full Step-Up Actually Works
The IRS states the rule plainly: if you own community property and your spouse dies, the total fair market value of the community property, including the part that belongs to you, generally becomes the basis of the entire property.2Internal Revenue Service. Publication 555 (12/2024), Community Property The condition is that at least half the community interest must be includible in the deceased spouse’s gross estate, which is almost always true for standard community property.
The dollar impact is easiest to see with a side-by-side. Take a couple who bought a rental for $200,000 as community property, held it while it appreciated to $800,000, and then one spouse dies:
- In a community property state, the entire property gets a new basis of $800,000. Sell it the next day, and the taxable gain is zero.
- In a common law state with joint tenancy, only the deceased spouse’s half steps up to $400,000. The surviving spouse’s half keeps the original $100,000 basis. Combined basis is $500,000, so an immediate sale produces a $300,000 taxable gain.
That $300,000 basis gap translates to roughly $50,000 to $70,000 in federal tax, depending on the survivor’s income bracket and whether the 3.8% net investment income tax applies. For couples with several appreciated assets or property held for decades, the community property rule can erase six figures of tax overnight.
The mixed-basis problem in common law states creates a second headache: the surviving spouse has to track two different basis figures for the same asset for the rest of their life. The community property full step-up leaves one clean number.
Which States Qualify
Nine states run on community property:2Internal Revenue Service. Publication 555 (12/2024), Community Property
- Arizona
- California
- Idaho
- Louisiana
- Nevada
- New Mexico
- Texas
- Washington
- Wisconsin
Five additional states let married couples opt into community property treatment through a community property trust: Alaska, Florida, Kentucky, South Dakota, and Tennessee. The catch is that the IRS has not confirmed these elective arrangements trigger the full step-up under 1014(b)(6). Publication 555 explicitly leaves them out of its coverage.2Internal Revenue Service. Publication 555 (12/2024), Community Property
Tax practitioners generally believe the full step-up should apply, because the statute refers to property held “under the community property laws of any State” and these states have enacted community property laws. Belief and IRS confirmation are not the same thing. Couples considering a community property trust should work with an estate planning attorney who drafts them regularly, because the trust has to satisfy every state-law requirement for community property status to have a chance of surviving IRS scrutiny.
What Actually Counts as Community Property
The full step-up only reaches assets that are community property at the moment the first spouse dies. Classification is where the planning work happens, and getting it wrong forfeits the benefit.
Community property generally includes what either spouse earns or acquires during the marriage while living in a community property state. Wages, investment returns on marital funds, and property bought with marital earnings are the typical examples. Each spouse owns an equal, undivided 50% interest in all of it.2Internal Revenue Service. Publication 555 (12/2024), Community Property
Separate property stays outside the community and does not get the double reset. Separate property covers what either spouse owned before the marriage, plus anything received during the marriage as a gift or inheritance directed to one spouse individually.
Commingling and Tracing
Separate property can lose its status if it gets mixed with community funds. The IRS recognizes that mixing separate property with community property converts the separate property into community property unless the separate portion can be traced back to its original source.3Internal Revenue Service. IRM 25.18.1 Basic Principles of Community Property Law The burden falls on whoever claims the property is separate.
Tracing means tracking deposits, withdrawals, and payments closely enough to show which funds came from separate sources and which came from community earnings. For an account holding both, if the separate portion becomes impossible to trace, most community property states treat the entire account as community property.3Internal Revenue Service. IRM 25.18.1 Basic Principles of Community Property Law
Mortgage payments made from community funds on a house one spouse owned before the marriage give the community a reimbursement right. Mortgage payments are relatively easy to trace because the amounts and dates are well documented.3Internal Revenue Service. IRM 25.18.1 Basic Principles of Community Property Law The practical takeaway: keep separate accounts and clean records for any asset you want to preserve as separate property, and clean records for community assets too if you want the step-up to hold up under review.
Title doesn’t settle the question either. A deed in one spouse’s name alone doesn’t automatically make property separate, and joint titling doesn’t guarantee community treatment. State law and the source of funds control the classification. Documentation matters more than what the deed says.
What Happens When You Move Between States
Couples who relocate from a community property state to a common law state can lose the full step-up on assets they built together. The controlling question is how the new state treats property that was community property in the old one.
Some common law states have adopted the Uniform Disposition of Community Property Rights at Death Act, which preserves the community character of property brought into the state. In those states, the IRS has indicated the full step-up under Section 1014(b)(6) should remain available because the property keeps its community property classification at death.
Other common law states effectively convert community property into a different form of co-ownership, like tenancy in common, once the couple takes up residence. The IRS treats that conversion as destroying the community property character and disqualifying the asset from the full step-up. Revenue Ruling 68-80 addressed a couple that moved from New Mexico to Virginia and retitled property as tenants in common; the IRS denied the surviving spouse the full basis adjustment.
The reverse move, from a common law state to a community property state, doesn’t automatically convert existing assets into community property. Property acquired before the move generally retains its separate or common law character unless the couple takes affirmative steps under state law, such as a transmutation agreement, to reclassify it. Some community property states have quasi-community property rules that treat imported assets as community property at death, but these vary by state.
If you’ve crossed state lines during your marriage, an attorney review of your asset classifications is worth the fee. The characterization of the property under state law at the time of death is what controls the tax outcome.
The Step-Down Risk
The basis adjustment at death cuts both ways, and this is the part that surprises people. When an asset’s fair market value is lower than its original cost, the basis steps down to that lower value. The surviving spouse permanently loses the ability to claim the built-in loss.4Internal Revenue Service. Gifts and Inheritances
In community property states, the step-down hits the whole asset. If a couple bought stock for $500,000 and it’s worth $300,000 when the first spouse dies, the surviving spouse’s basis in the full position becomes $300,000. The $200,000 loss vanishes.
Couples holding significantly depreciated community property may want to sell before either spouse dies, locking in the capital loss while it can still offset other gains or income. Most of the planning conversation focuses on appreciated assets, which is exactly why the step-down catches people off guard.
Establishing the New Basis
The stepped-up basis equals the asset’s fair market value on the date of death.5Internal Revenue Service. Publication 551 (12/2025), Basis of Assets Documenting that value with defensible evidence is the surviving spouse’s most important administrative task, because the IRS can challenge the claimed basis whenever the asset is eventually sold.
Publicly traded securities are simple: use the closing price on the date of death, or the average of the high and low trading prices that day, depending on the method chosen. For real estate, closely held businesses, art, and collectibles, a professional appraisal is necessary. The IRS expects appraisals to follow its Real Property Valuation Guidelines, which require identifying the specific property interest being valued, documenting condition and comparable sales, and analyzing value through recognized methodologies like the market, income, or cost approach.6Internal Revenue Service. Real Property Valuation Guidelines Residential appraisals typically run $200 to $600, with complex or high-value properties costing more.
Keep the appraisal reports indefinitely. If the surviving spouse sells years later, the appraisal completed close to the date of death by a qualified professional is your best evidence.
Inflating a valuation to inflate the basis carries real consequences. The IRS imposes a 20% accuracy-related penalty on any tax underpayment caused by a substantial valuation misstatement, and that doubles to 40% for a gross valuation misstatement, defined as reporting a value at 40% or less of the correct amount.7Office of the Law Revision Counsel. 26 U.S. Code 6662 – Imposition of Accuracy-Related Penalty on Underpayments Picking a round number that “sounds about right” for real estate or a business interest is exactly what triggers an audit adjustment.
Trusts and the Step-Up
Community property held in a revocable living trust still qualifies for the full step-up. IRC 1014(b)(2) and (b)(3) cover property transferred to a revocable trust during the decedent’s lifetime, and moving assets into the trust doesn’t change their community property character.1Office of the Law Revision Counsel. 26 USC 1014 – Basis of Property Acquired From a Decedent
Irrevocable trusts are different. Assets transferred to an irrevocable trust during the grantor’s lifetime may not be considered part of the decedent’s estate and may not qualify for any step-up at all. Couples using irrevocable trusts for asset protection or estate tax planning should confirm with their attorney that the trust preserves the community property step-up. Losing that benefit can dwarf whatever the trust was designed to save.