Step-Up in Basis at Death: How Texas Community Property Amplifies the Tax Benefit

When someone dies, most of their assets receive a step-up in tax basis to the fair market value at the date of death. This is one of the most valuable tax benefits in estate planning, and it is provided by federal law under Internal Revenue Code § 1014. For Texas residents, the step-up benefit is even more powerful because of the state's community property rules.

This guide explains how the step-up in basis works, why Texas community property gives both halves a step-up (not just the deceased's half), and which assets do not qualify. Understanding this can save your family tens or hundreds of thousands of dollars in capital gains taxes.

What Is Tax Basis?

Before explaining the step-up, it helps to understand basis. Your tax basis in an asset is essentially what you paid for it (or its value when you received it). When you sell an asset, you pay capital gains tax on the difference between the sale price and your basis.

Example:

You bought stock for $10,000 (your basis is $10,000)
The stock grew to $80,000
You sell for $80,000
Your capital gain is $70,000 — and you owe capital gains tax on that amount

Long-term capital gains rates are 0%, 15%, or 20% depending on your income. At a 15% rate, the tax on that $70,000 gain would be $10,500.

The Step-Up: How It Works at Death

Under IRC § 1014, when someone inherits an asset, their basis is stepped up to the fair market value at the date of the decedent's death — not what the decedent originally paid.

Using the same stock:

Decedent bought stock for $10,000
At death, stock is worth $80,000
Heir inherits stock with a new basis of $80,000
Heir immediately sells for $80,000
Capital gain: $0 — no tax owed

The $70,000 of gain that built up during the decedent's lifetime simply disappears from a tax standpoint. This is sometimes called "erasing embedded gain."

This is one of the primary reasons people hold appreciated assets until death rather than selling or gifting them during their lifetime. The step-up can eliminate enormous tax liability.

Texas Community Property: The Double Step-Up

Here is where Texas residents have a significant advantage over residents of non-community property states.

Separate Property States: Only Half Steps Up

In states that do not have community property (most of the country), a married couple holds property either jointly or separately. When one spouse dies:

Only the deceased spouse's share gets a step-up
The surviving spouse's share retains its original (carryover) basis

Example in a separate property state: Married couple in Ohio buys stock together for $20,000 ($10,000 each as basis). Stock grows to $100,000 at the husband's death. The husband owned half.

Husband's half ($50,000): steps up to $50,000 ✓
Wife's half: retains original basis of $10,000
If wife sells all stock for $100,000: $40,000 gain (wife's half) is taxable

Texas Community Property: Both Halves Step Up

Under IRC § 1014(b)(6), all community property — not just the deceased spouse's half — receives a step-up to the fair market value at death. Both spouses' interests in community property get a new basis when one spouse dies.

Same example in Texas: Married couple buys stock for $20,000 as community property ($10,000 community basis). Stock grows to $100,000 at the husband's death.

Entire $100,000 steps up to $100,000 — both the husband's half and the wife's half
If wife sells all stock for $100,000: $0 taxable gain
Tax savings compared to Ohio: capital gains on $40,000 avoided

At a 15% long-term capital gains rate, that is $6,000 in savings on a single investment. Scale this to a home worth $600,000 that was purchased for $200,000, or a stock portfolio worth millions, and the benefit becomes enormous.

Why This Matters for Texas Estate Planning

The community property double step-up is one of the strongest arguments for keeping assets as community property rather than converting them to separate property. Converting community property to separate property (through a partition agreement) can result in losing the double step-up for the surviving spouse.

Married couples living in Texas who own appreciated assets should understand this benefit before making any decisions about asset titling, transfers to family members, or converting community to separate property.

Real-Number Examples

Example 1: The Family Home

A Texas couple bought their home in 1990 for $150,000. At the wife's death in 2026, the home is worth $750,000.

Original basis: $150,000
Gain built up: $600,000
With step-up: new basis = $750,000 for the entire property
Surviving husband inherits and sells for $750,000: $0 taxable gain
Without the community property double step-up: only half would step up; husband's $75,000 original basis in his half would remain — creating a $300,000 taxable gain on his half

At 20% capital gains rate: $60,000 tax savings from the community property double step-up alone.

Example 2: Stock Portfolio

A Texas couple has $500,000 in investments (community property) with an original cost of $150,000 ($350,000 in built-up gain). When one spouse dies in 2026:

Entire $500,000 steps up to $500,000
Surviving spouse sells entire portfolio: $0 federal capital gains tax
Texas has no state income tax, so no state capital gains either
Total savings: up to $70,000 at 20% rate

What Assets Get a Step-Up

The step-up applies to most inherited assets:

Stocks and mutual funds held in taxable brokerage accounts
Real estate (primary home, rental property, vacation home, land)
Business interests (partnership interests, S-corp shares, closely-held businesses)
Personal property of significant value (art, collectibles, jewelry)
Community property with right of survivorship
Property in a revocable living trust — trust assets still get a step-up because the grantor retained control

What Does NOT Get a Step-Up

Several important asset categories do not receive a step-up in basis:

Retirement Accounts (IRAs, 401(k), 403(b))

Retirement accounts are pre-tax money — the IRS has never taxed those dollars, and it intends to collect. When beneficiaries inherit a traditional IRA or 401(k), they owe ordinary income tax on every dollar withdrawn. There is no step-up. This is a major reason why inherited IRAs are often the most heavily taxed assets in an estate.

Strategy implication: It can make sense to spend down taxable accounts (which get a step-up) rather than IRAs during retirement, so that the step-up eliminates the taxable gain, while the IRA is left to beneficiaries who may be in lower tax brackets.

Annuities

Deferred annuities inside non-retirement accounts carry deferred income tax, not capital gains. Inherited annuities are subject to income tax on the earnings portion, with no step-up benefit.

Roth IRA

Roth IRA contributions have already been taxed. Qualified withdrawals are tax-free for both the original owner and inherited beneficiaries. But there is no step-up to speak of because the money is already after-tax.

US Savings Bonds

Accrued interest on savings bonds is taxable as ordinary income when cashed in. The step-up does not eliminate this ordinary income tax.

Carryover Basis for Gifts vs. Step-Up at Death

If you give an appreciated asset as a gift during your lifetime, the recipient takes your original basis — they do not get a step-up. This is called carryover basis.

Example: Parent bought stock for $10,000. Stock is now worth $80,000. Parent gives it to adult child as a gift.

Child's basis: $10,000 (parent's original basis carries over)
If child sells for $80,000: $70,000 taxable gain

Compare to inheriting the same stock at death: new basis of $80,000, zero taxable gain.

This is why financial advisors often counsel clients not to gift highly appreciated assets to adult beneficiaries during their lifetime. It is usually far more tax-efficient to hold the asset and let the beneficiary inherit it with a stepped-up basis. The exception is when the asset is expected to depreciate, or when there are compelling non-tax reasons to gift it.

Planning Strategies

Hold Appreciated Assets Until Death

For low-basis assets you do not need to sell, holding until death allows the step-up to eliminate embedded capital gains. This applies to real estate, long-held stocks, and business interests.

Keep Community Property as Community Property

Ensure appreciated assets acquired during marriage stay titled as community property. Do not convert to separate property without understanding the tax consequence. If you have executed a partition agreement that converted community property, consult a tax advisor.

Consider Asset Location

Place assets with the most embedded gain in accounts or titles that will receive the step-up at death. Tax-advantaged retirement accounts (IRAs) will not benefit from a step-up, so keep your most appreciated non-retirement assets positioned to take advantage of it.

"Date of Alternate Valuation" Option

For large estates subject to federal estate tax, the executor can elect to value assets six months after the date of death rather than at death. This can be useful if asset values decline after death. The basis for heirs follows whichever valuation date is used.

Frequently Asked Questions

Does Texas have a capital gains tax?

No. Texas has no state income tax and no state capital gains tax. Inherited assets sold at a step-up in basis owe zero federal capital gains tax and zero state tax.

Does the step-up apply to property in a living trust?

Yes. A revocable living trust is treated as if the grantor still owns the assets for tax purposes. Assets in a revocable trust receive a full step-up at the grantor's death, just like assets held outright.

What about assets held in joint tenancy (not community property)?

For assets held as joint tenants with right of survivorship (rather than community property), only the deceased co-owner's share steps up. The surviving joint tenant's original basis carries over for their share. This is another reason why Texas married couples typically benefit more from community property titling than joint tenancy.

What if the estate is subject to federal estate tax?

The step-up in basis applies regardless of whether the estate pays estate tax. For estates above the federal exemption, both the estate tax and the stepped-up basis apply simultaneously. Estate tax is paid on the value of assets at death; heirs then have a basis equal to that same value.

Related Guides

Sources:

"Internal Revenue Code § 1014, Basis of Property Acquired from a Decedent," Cornell Law School Legal Information Institute, 2025, https://www.law.cornell.edu/uscode/text/26/1014
"Publication 550, Investment Income and Expenses," IRS, 2025, https://www.irs.gov/publications/p550
"Community Property," IRS, 2025, https://www.irs.gov/publications/p555

This guide provides general information about federal tax rules and Texas community property. Tax laws change. Consult with a tax professional or estate planning attorney for advice specific to your situation.