When does a widow get a full step-up in basis?

Dear Mr. Premack: A married couple had brokerage account held “Joint with right of survivorship”. Funds and stocks were purchased over many years, using only community income. Husband died. Is there a full step-up in basis, as community property? Or is the step-up in basis only on the deceased husband’s half? – DPR

Since 1954, section 1014 of the Internal Revenue Code has granted a special benefit to those who live in community property states. For example, John and Susan have assets valued at $6 million, but they only invested $2 million (the rest is growth over their 50 year marriage). John dies, and his estate owns half the assets, or $3 million. He leaves it all to Susan, whether through his Will, a trust, or a right of survivorship arrangement.

In a common law state (like New York) Susan would get a step-up in basis in John’s $3 million. If she liquidated all of their holdings right after John’s death, she would pay no capital gains tax on John’s half due to the step-up in basis. But Susan’s half would not get a step-up, so she would pay capital gain tax on her $2 million gain.

In a community property state (like Texas) Susan would get a step-up in basis in the entire $6 million (John’s half and her half). If she liquidated, she would pay no capital gain tax on the entire $4 million gain. That rule made living in a community property state a better choice for tax savings.

However, that 1954 law was modified by the Bush Administration in 2001, though the change did not take effect until January 1, 2010. Under section 1022 of the Internal Revenue Code, community property still gets the same special treatment, but there is a cap of $3 million on the step-up for spouses. If John died in Texas in 2009 there would be no capital gain tax. If John died in Texas in 2010, Susan’s step-up in basis is capped at $3 million so upon liquidation she must pay capital gain tax on the $1 million excess. She’s still better off in a community property state, but pays more tax under the 2001 law than should would have under the 1954 law.

Paul Premack is a Certified Elder Law Attorney and a Five Star Wealth Manager (Texas Monthly Magazine 2009-2013) practicing estate planning and probate law in San Antonio.

Original Publication: San Antonio Express News, February 19, 2010

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