Community Property: Cost Basis Implications

Understand The Treatment Of Community Property In Texas

How does Community Property work? Assets titled as Community Property (Or trusts that qualify) save you money on taxes by adjusting or “stepping up” the basis of the entire property after the death of one member of a couple. When you and your spouse invest in property jointly — be it real estate, stocks, or other assets — it becomes what is called “Community Property” if you live within any of the nine applicable states.

Federal tax code section 1014(b)(6) provides that community property assets step up 100 percent in basis at the death of one spouse (even though the other spouse survives). Example: Stock worth $100 at date of death with a cost basis of $20 steps up to $100 basis upon date of death. This means that the $80 built-in capital gain that would be taxed upon the sale of the asset disappears.

Community Property differs from “common law” states (non-community property states) where step up occurs only to the extent of the decedent’s ownership (one-half of property held in “joint tenancy” or tenancy-by-the-entirety). Example: Stock worth $100 at date of death with basis of $20 has a new basis of $60 at date of death, which is $50 decedent’s share (one-half of $100) plus $10 survivor’s share (one-half of $20).

Obviously, the tax advantage associated with Community Property step-up in basis can be significant for the surviving spouse or other heirs.

Getting to know your basic Community Property terminology

• Community property: Assets a married couple acquires by joint effort during marriage if they live in one of the nine community property states: Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin.

• Basis: What you paid for an asset. The value that is used to determine gain or loss for income tax purposes. A higher basis means less capital gains tax.

• Stepped-up basis: Assets are given a new basis when transferred by inheritance (through a will or trust) and are revalued as of the date of the owner’s death. The new basis is called a stepped-up basis. A stepped-up basis can save a considerable amount of capital gains tax when an asset is later sold by the new owner.

• Double step-up: Because of a tax loophole, community property receives a basis adjustment step-up on the entire property when either one of the spouses dies. Therefore, if a surviving spouse sells community property after the death of their spouse, the capital gain is based on the increase in value from the first spouse’s death (where the basis got adjusted on both spouses’ shares) to the value at the date of the sale. This allows the survivor to save money on capital gains tax liability.