How does the basis adjustment work for community property upon the death of a decedent?

In community property states, the basis adjustment upon the death of a decedent benefits both the decedent's share and the survivor's share, leading to an adjustment to the fair market value of the entire property at the time of death. This is significant because it allows the surviving spouse to potentially minimize capital gains taxes when they eventually sell the property.

When one spouse dies, the entire property, regardless of who originally contributed to its acquisition, receives a step-up in basis. This means that the surviving spouse's basis in the property is adjusted to reflect its fair market value at the date of the decedent's death. This adjustment applies to the entire value of the property, not just the portion that belonged to the deceased spouse.

This rule is particularly beneficial in real estate transactions, where property values may have appreciated significantly over time. Consequently, when the surviving spouse later sells the property, they can realize capital gains based on the new, higher basis rather than on the original purchase price, thereby reducing the amount of taxable gain.

This understanding of community property and the basis adjustment reinforces the importance of estate planning, particularly for couples who live in community property states, as it can significantly impact their financial decisions following a death in the family.