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How Step-Up in Basis Works

Should you hold appreciated assets in community property or joint tenancy?  That depends if you live in a community property state like California.

If so, let’s start with the following assumptions:

  1. You bought land as an investment in 2000 for $40,000.  This is called your BASIS.
  2. Today, in 2018, it’s worth $220,000.

Capital Gains

If you were to sell the land today for $220,000, you would incur a taxable gain of $180,000, the difference between your basis ($40,000) and your sale price ($220,000).  Such profits are subject to income tax at capital gains rates.

Enter the Step-up in Basis

Instead, if you died and your surviving spouse then sold the land, the tax picture would be different.  At the date of death, Section 1014(b) of the Tax Code permits the basis of the decedent’s property to be stepped up to its value as of date of death.

What about the Surviving Spouse’s Half of the Investments?

If the title is in joint tenancy, the survivor’s share will retain its original cost basis ($20,000) (See IRS Sec. 1014(b)(9)) and the decedent’s share steps up to $110,000.  If the title is in community property though, the survivor’s share steps-up to $110,000 as well (See IRS Sec. 1014(b)(6)).  Thus, the capital gains in a joint tenancy would be $90,000 (the sale price of $220,000 less the revised basis of $130,000) whereas the capital gains in a community property arrangement would be $0 (because the revised basis would step up completely to $220,000).

 

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