Texas Community Property and the Double Step-Up in Basis

Texas is a community property state, and that brings a little-known income tax advantage for married couples. When the first spouse dies, the tax basis of both halves of the couple’s community property is generally reset to its value at death. Tax professionals call this the “double step-up,” and it can let a surviving spouse sell the house, stock or a rental with little or no capital gains tax.

What Is a “Step-Up in Basis”?

Your basis in property is generally what you paid for it, adjusted for improvements and depreciation. When you sell, you pay capital gains tax on the difference between the sale price and your basis. Under 26 U.S.C. § 1014, property acquired from someone who died generally takes a new basis equal to its fair market value on the date of death. Decades of built-up gain can disappear.

How Community Property Gets a Double Step-Up

In most states, when a married couple owns property jointly and one spouse dies, only the deceased spouse’s half gets a new basis. The survivor’s half keeps the original cost.

Community property is treated differently. Under § 1014(b)(6), the surviving spouse’s half of community property is also treated as acquired from the deceased spouse, as long as at least half of the property’s value was included in the deceased spouse’s estate. In Texas, property acquired by either spouse during the marriage is presumed to be community property (Texas Family Code §§ 3.002–3.003), so for most long-married Texas couples, the double step-up applies to most of what they own.

An Example: The Family Home in Austin

A couple bought their Austin home in 2000 for $250,000. When the husband dies, it is worth $1,250,000.

• Texas community property: the whole house gets a new basis of $1,250,000. If the wife sells it for that price, there is no capital gain.
• A separate-property state: only his half is stepped up. Her basis would be $125,000 (her half of the purchase price) plus $625,000 (his stepped-up half), or $750,000. A sale at $1,250,000 would leave a $500,000 gain before any home sale exclusion.

The same rule applies to a brokerage account, a rental property or a business interest that is community property. For rentals, the new basis also restarts depreciation for the survivor. See estate planning for real estate investors.

What Can Reduce or Undo the Benefit

• Separate property. Property one spouse owned before marriage, or received by gift or inheritance, is separate property. Only the deceased owner’s separate property gets a new basis; the survivor’s separate property does not.
• Lifetime gifts. Property given away during life keeps the giver’s old basis (26 U.S.C. § 1015). Deeding the house to the children “to avoid probate” can cost them the step-up and leave them a large capital gain when they sell. A trust or a transfer on death deed can usually avoid probate without giving up the step-up.
• Agreements that change property character. A partition or premarital agreement that converts community property into separate property can affect the step-up. Review the tax effect before signing one.
• Values that have dropped. The rule works both ways. Property worth less than its cost at death steps down, and the loss is gone.
• Retirement accounts. IRAs, 401(k)s and annuities do not get a step-up. Beneficiaries pay income tax on withdrawals.

Keep the Records

The step-up only helps if you can prove the value. After the first death, get a date-of-death appraisal of the home and any real estate, and date-of-death statements for investment accounts. Keep them with the estate records. If the family files a federal estate tax return to keep the deceased spouse’s unused exemption, the values on that return help document basis too. See portability for surviving spouses.

How This Fits Your Estate Plan

A well-drafted Texas living trust for a married couple keeps track of what is community and what is separate, so the double step-up is preserved and easy to prove. It also avoids probate without the tax cost of deeding property away. See the best type of trust for a married couple in Texas and our estate tax planning page. Property left in a marital trust receives another new basis at the surviving spouse’s death; property in a bypass trust does not.

Turner Henington is a former KPMG tax accountant. We look at basis and capital gains along with estate tax and probate when we design a plan, and we work with your CPA.

Frequently Asked Questions

Does a revocable living trust affect the step-up?

Generally no. Assets in a revocable trust are still included in the owner’s estate, so they get the step-up at death. A married couple’s trust should keep community and separate property identified.

Does the property get another step-up when the second spouse dies?

Generally yes. Property included in the surviving spouse’s estate gets a new basis again at their death.

Do we need an appraisal?

For a home or other real estate, a date-of-death appraisal is the best evidence of value. For investment accounts, the brokerage can provide date-of-death values.

Does this apply if we moved to Texas from another state?

It depends on how and where the property was acquired. Property bought while living in a separate-property state may not be community property. We review this for couples who are new to Texas.

Talk to us. Call (512) 737-8404 or book a free consultation.

Sources

• 26 U.S.C. § 1014 (basis of property acquired from a decedent)
• 26 U.S.C. § 1015 (basis of property acquired by gift)
• Texas Family Code chapter 3 (marital property)
• IRS Publication 555, Community Property
• IRS Publication 551, Basis of Assets

Written by Turner Henington, attorney and former KPMG tax accountant, Henington Lewis Law Firm PLLC. This article is general information, not legal or tax advice for your situation.