Step up in basis and community property states – don’t make this mistake!
Step up in basis in a community property state is not a simple concept. There are many nuances to grasp. In this blog we cover the basics of how step up in basis works in a community property state such as California, and what the common mistakes are that people make (that should be avoided).
Before we get on to the blog, we wanted to invite you to sign up for our newsletter. We publish periodic updates on wealth management in the state of California, as we are a financial advisor firm based in La Jolla.
Please remember that this cannot be construed as tax or financial advice; for recommendations specific to your situation please consult a professional.
In the blog, we’ll talk about:
The definitions of the basic terms related to cost basis and community property states.
The common mistakes people make with step up in cost basis in a community property state.
What to know about cost basis for assets on which you have a capital loss in a community property state such as California.
Let’s get on to the blog!
Defining some terms about cost basis
Capital gain: difference between what you bought the asset for, and what you sold it for
Step up basis: when the original cost basis of an assets gets replaced by its market value
Double step-up in basis: a rule that applies in community property states. When one spouse dies, the asset gets stepped up in basis. When the surviving spouse dies, the asset gets stepped up in basis again.
Community property state: each spousal partner in a marriage is assumed to own 50% of all assets that were acquired by the couple during the time in which they were married. As of 2021, there were nine community property states in the US.
We provide in depth definitions of the aforementioned terms in a past blog we wrote about step up in basis for California residents. Please review this article if you want further clarity.
So now that we’ve covered what the core elements are, how do they need to work together? What key pieces of information does a resident of a community property state such as California need to know about step up in basis to avoid making mistakes?
Let’s discuss a few of them.
Step up in cost basis – common mistakes
We’ve discussed the step up in basis mistakes that people commonly make in other blogs. Please refer to our past blog for an in-depth explanation. Here is a summary of two very common ones that we see.
#1
Holding the title of a home in joint tenancy with a spouse is a step up in basis mistake in a community property state such as California. If you do this, when one spouse dies the other one must keep the original cost basis on one half of the house. In other words, you will only get a step up in basis on half the house.
#2
There are certain pitfalls associated with owning a home with your children. If you intend to allow your heirs to avoid probate on your real property after your passing, you don’t want to own the real property with your children. Use a trust instead. If not, your children will recognize a full capital gain on the home, as the step up in basis rule will not be able to apply.
Step up basis, capital losses, and community property states
You often hear about how, if you are in a community property state, everything should be registered as community property. But that’s not the case if you have an asset that has a big loss.
Here’s why.
If you die with that asset, you’ll get a step down in basis, and that loss will never make it to your tax return. If you instead register that asset in joint tenancy and one of you passes away, you will still be able to sell that property and get 50% of the loss onto your tax return. So, keep that in mind as you register your assets.
Contact us
We hope that this blog about the tax issues surrounding step up in basis in a community property state has been helpful to you. Please remember that nothing in this article should be interpreted to be a recommendation specific to your situation; the information contained herein is general in nature. For tax or financial advisor, consult a professional advisor.
If you have any other questions about step up in cost basis or anything else, feel free to reach out to us. We’ll be happy to speak with you.
Sources
Perez, William. (2020, December 13th). The Balance. Tax Issues When You Live in a Community Property State. Retrieved from https://www.thebalance.com/community-property-states-3193432