Community Property in California: The Hidden Tax Benefit Every Married Couple Should Know
Community property in California – one of the greatest tax advantages available to married couples has nothing to do with income taxes or estate taxes.
Instead, it involves capital gains taxes.
Because California is a community property state, many married couples receive a 100% step-up in cost basis when the first spouse dies. This often allows the surviving spouse to sell appreciated assets—especially a home or stocks—with little or no capital gains tax.
Unfortunately, many people unintentionally lose this benefit because their property is titled incorrectly or because they do not understand how community property works.
As a Living Trust Attorney in Carmel Valley and Estate Planning Attorney in San Diego, I regularly help families preserve this valuable tax benefit through proper trust planning.
What Is Community Property?
Under California law, property acquired by either spouse during marriage while living in California is generally presumed to be community property, regardless of whose paycheck purchased it or whose name appears on the account or deed (subject to certain exceptions and evidence that may rebut the presumption).
Generally speaking:
Community Property includes:
- Family home purchased during marriage
- Earnings of either spouse during marriage
- Investment property purchased with marital earnings
- Bank accounts funded with marital income
- Brokerage accounts built during marriage
- Vehicles purchased during marriage
- Business interests acquired during marriage
Each spouse owns an undivided one-half interest in the entire asset. Even if the title is held in one of the spouse’s name.
What Is Separate Property?
Separate property generally includes:
- Property owned before marriage
- Gifts received by one spouse
- Inheritances received by one spouse
- Property acquired after permanent separation
- Assets kept separate and not converted into community property
Separate property follows very different tax rules when one spouse dies.
What Is Cost Basis?
Cost basis is generally what you invested in an asset for tax purposes.
For example:
Purchase Price: $400,000
Current Value: $1,200,000
Original Cost Basis:
$400,000
If the property is sold today:
Capital Gain:
$800,000
The larger the appreciation, the larger the potential capital gains tax.
What Is a Step-Up in Cost Basis?
When someone dies, many inherited assets receive a new tax basis equal to their fair market value on the date of death (or the alternate valuation date if elected). This is called a step-up in basis.
Suppose your home has:
Original Basis:
$400,000
Value at death:
$1,200,000
After a full step-up:
New Basis:
$1,200,000
If the property is sold immediately for $1,200,000:
Capital Gain:
$0
That can save hundreds of thousands of dollars in taxes.
Why California Is Different
California is one of the community property states.
Federal tax law provides a unique benefit for community property.
When the first spouse dies, both halves of community property generally receive a new basis equal to fair market value—not just the deceased spouse’s half.
This is commonly called the 100% step-up in basis.
Example: Community Property
John and Mary purchase a home for:
$500,000
Twenty-five years later it is worth:
$2,000,000
John dies.
Because the home is community property:
Old Basis:
$500,000
New Basis:
$2,000,000
If Mary immediately sells for $2,000,000:
Capital Gain:
$0
The appreciation that occurred during John’s lifetime has effectively been eliminated for income tax purposes.
Compare That to Separate Property
Assume instead John owned the home as his separate property before marriage.
If John dies owning the property:
The property included in John’s estate generally receives a step-up in basis.
However, if spouses own appreciated property as joint tenants rather than community property, only the deceased spouse’s one-half interest generally receives a step-up, while the survivor’s one-half typically retains its original basis. This often produces a much lower overall basis than community property.
This difference alone can create hundreds of thousands of dollars of additional taxable gain.
Requirements for the 100% Step-Up in Basis
Simply being married is not enough.
Several requirements generally must be met.
1. The Property Must Be Community Property
The asset must actually qualify as community property under California law.
Separate property does not receive the same treatment.
2. At Least One-Half Must Be Included in the Deceased Spouse’s Taxable Estate
Federal law requires that at least one-half of the community property be includible in the deceased spouse’s gross estate for estate tax purposes. Fortunately, this requirement is satisfied in most ordinary estate planning situations involving community property.
3. Community Property Status Must Be Preserved
Sometimes spouses accidentally destroy community property status by:
- Changing title incorrectly
- Mixing separate and community funds
- Signing documents that change the character of ownership
- Failing to properly document ownership when transferring assets
Proper legal advice can help avoid these problems.
4. The Property Must Generally Be Included in the Taxable Estate
Most assets held in a revocable living trust remain includible in the deceased spouse’s gross estate, which is one reason revocable trusts typically preserve the step-up in basis. By contrast, assets transferred to certain irrevocable trusts that are excluded from the gross estate may not receive a basis adjustment at death.
Does Putting Property Into a Living Trust Eliminate the Step-Up?
No.
This is one of the biggest misconceptions.
A properly drafted California revocable living trust does not eliminate the community property step-up.
In fact, many married couples intentionally transfer their community property into a joint revocable trust because the property generally retains its community property character while also avoiding probate.
Does This Apply Only to Real Estate?
No.
The same rules may apply to many appreciated community assets, including:
- Brokerage accounts
- Investment portfolios
- Rental properties
- Closely held businesses
- Certain valuable personal property
Each asset should be analyzed individually because characterization and titling matter.
Why Proper Estate Planning Matters
Many families assume that all jointly owned property automatically receives a full step-up in basis.
That is not always true.
How property is titled, whether it is community or separate property, whether it has been transmuted, and how it is held in a trust can significantly affect the tax result.
A properly prepared estate plan does more than avoid probate—it can also preserve valuable income tax benefits that may save your family substantial amounts in capital gains tax.
Frequently Asked Questions
Is California a community property state?
Yes. California is one of the nine community property states. Most property acquired during marriage is presumed to be community property unless an exception applies.
Does every asset receive a 100% step-up in basis?
No. Only assets that qualify under the applicable tax rules—such as qualifying community property under IRC § 1014(b)(6)—receive a full step-up. Separate property and incorrectly titled assets may receive different treatment.
Does a living trust eliminate the step-up in basis?
No. A properly drafted California revocable living trust generally preserves the community property step-up while also avoiding probate.
Can changing title affect my taxes?
Absolutely. The way an asset is titled can significantly affect whether the surviving spouse receives a full or only partial step-up in basis.
Should I review my trust if it was created years ago?
Yes. Older trusts and deeds may not preserve community property treatment in the most tax-efficient manner. Periodic reviews help ensure your estate plan still meets your goals and takes advantage of current law.
Protect Your Family’s Tax Benefits
For many California families, preserving the community property step-up in basis can save far more than the cost of creating a living trust.
If you are married, own appreciated assets, or want to make sure your estate plan maximizes available tax benefits, reviewing how your property is titled is an important part of the planning process.
As a Living Trust Attorney in Carmel Valley and Estate Planning Attorney in San Diego, I help families create estate plans that avoid probate while preserving valuable tax advantages for future generations.