How is community property valued for the surviving spouse? The ‘full-step up’.

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Summary and Background

“Bifurcated” describes the two-pronged approach in the taxation of property received as a gift or inheritance. In simple terms, if you receive a gift (but not an inheritance) you inherit the tax basis of the donor, meaning the original cost of the property adjusted for factors like depreciation as per IRS Publication 551. Therefore, any future gains or losses upon the sale of the gift will be taxed considering both the donor’s and your own holding period. However, losses can only be claimed for your holding period. This system, called the bifurcated basis rule, was designed to prevent tax loss shifting from low to high bracket individuals. The donor might be subject to gift tax, and a recipient’s basis may increase to reflect the tax liability.

In contrast, if you inherit property, the basis is recalculated to the property’s market value at the decedent’s time of death, typically resulting in a step-up basis. Neither the decedent nor the recipient is subject to income tax in this case, and estate taxes are usually offset due to the substantial basic exclusion amount. As of 2021, the unified credit for gift and estate taxes was $11,700,000, set to halve in 2025.

How is Community Property of the Surviving Spouse Valued?

As we have discussed elsewhere (What is the bifurcated basis rule?), those who acquire property from a decedent benefit from a cost basis step up. In California, the intestate share of the surviving spouse is the one-half of the community property that belongs to the decedent. This property, at its fair market value, is part of the decedent’s estate. What happens to the surviving spouse’s half of community property?

Under IRC 1014(b)(6), the community property of the surviving spouse is also subject to the stepped-up cost basis. This ‘full’-step up has been called the primary federal tax advantage of community property. However, what is and what is not community property may not be as clear as one may assume, see, for example, this law review article Section 1014(b)(6) and the boundaries of community property.

What is meant by the uniform basis rule?

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