When a beneficiary inherits assets, the cost basis is adjusted to the fair market value at the decedent’s date of death under IRC §1014, “Basis of property acquired from a decedent”. This adjustment is commonly known as a step-up in basis. If you buy a stock for $100,000 and it grows to $1 million, selling it during your life triggers capital gains tax on the $900,000 appreciation. If you hold it until death, your heir receives the stock with a new cost basis of $1 million. They can liquidate it immediately and owe zero income tax. If they sell it later for $1.1 million, they only pay tax on the post-death gain of $100,000.
The legal form of asset co-ownership dictates how this step-up is applied. Married and unmarried co-owners typically choose between Joint Tenancy With Right Of Survivorship (JTWROS) and Tenancy in Common (TIC).
JTWROS requires two or more co-owners to hold equal, undivided shares in an asset. When one owner dies, their share automatically passes to the surviving owner by operation of law. This transfer bypasses probate entirely, simplifying estate administration. However, adding a non-spouse as a joint tenant during your lifetime is treated as a taxable gift of a fractional interest, which requires filing Form 709 if the value exceeds the annual gift tax exclusion ($19,000 in 2026).
TIC allows two or more parties to own unequal or equal fractional interests in a property. There is no right of survivorship. Each owner’s share is distinct and can be bequeathed via a will or trust to any beneficiary they choose. When a tenant in common dies, their share goes through probate (unless held in a trust) and is included in their taxable estate.
The basis adjustment rules differ significantly between the two. Under a TIC structure, only the decedent’s fractional interest passes to their heirs, and only that portion receives a basis step-up to its date-of-death value. The surviving co-owner’s basis in their own share remains unchanged.
For non-spouse joint tenants (such as a parent and child), the cost basis adjustment depends on the contribution rule. When a non-spouse joint tenant dies, the IRS presumes the decedent paid for 100% of the asset, including the entire value in their gross estate under IRC §2040(a), unless the survivor can prove they contributed capital. The adjusted cost basis for the survivor is the sum of:
For spouses holding property as joint tenants, the rules are different. Under IRC §2040(b), only 50% of the property is included in the first-to-die spouse’s gross estate, regardless of who paid for the asset. Consequently, only 50% of the property receives a basis step-up. The surviving spouse’s new cost basis is calculated as:
This partial step-up is a significant disadvantage when compared to community property titling.
If you are domiciled in a community property state (such as California, Texas, Washington, or Arizona), holding title to appreciated assets as joint tenants is a costly mistake. Under IRC §1014(b)(6), community property receives a double step-up: when the first spouse dies, 100% of the community property receives a new basis adjusted to the fair market value at death.
Compare two scenarios for a California couple holding a brokerage portfolio that has grown from an original cost basis of $1 million to a fair market value of $5 million, assuming the survivor liquidates it and other income fills the lower brackets (Table 23.7). Under JTWROS only the decedent’s 50% share steps up, leaving the survivor a $3 million basis (the $500,000 original basis of their own half plus the $2.5 million date-of-death value of the decedent’s half) and a $2 million taxable gain on sale. Held as community property, the entire basis steps up to $5 million and the survivor sells at zero gain.
The California figure reflects the top 13.3% rate, which includes the 1% Behavioral Health Services Tax surcharge on taxable income above $1 million; the 3.8% line is the net investment income tax (section “Net Investment Income Tax (NIIT)”). Choosing joint tenancy instead of community property costs the surviving spouse roughly $742,000 in unnecessary taxes. In community property states, JTWROS is a massive financial leak.
To obtain the double step-up, spouses can hold title as “community property” or “community property with right of survivorship” (which combines the full basis step-up with probate avoidance). Spouses can also convert separate property into community property by executing a transmutation agreement under state law, as detailed in section “Separate Property, Community Property, and Commingling”. For more details, consult IRS Pub. 555, IRS Pub. 551, “Basis of Assets”, and IRC §1014.
If you live in a common-law state (any state other than the nine community property jurisdictions), you are normally locked out of the double basis step-up. However, Tennessee, Alaska, Florida, Kentucky, and South Dakota allow non-residents to opt into community property treatment by establishing a Community Property Trust. Under the Tennessee Community Property Trust Act (T.C.A. §35-17-101 et seq.), spouses can transfer assets to a trust that explicitly elects community property status.
To qualify, the trust must have at least one qualified trustee (a Tennessee resident or a corporate trustee located in Tennessee) and carry explicit statutory warnings. If structured correctly, the assets held in the trust should qualify for a 100% basis step-up upon the death of the first spouse under IRC §1014(b)(6). While the IRS has not issued a formal revenue ruling validating this for non-residents of opt-in states, the statutory language of §1014(b)(6) refers to property that is considered “community property under the laws of any State.” For couples holding highly appreciated real estate or business interests, the potential tax savings make the Tennessee Community Property Trust a powerful vehicle to discuss with counsel.
The income-tax step-up under IRC §1014 and California real property tax reassessment rules are governed by different statutes, and confusing them can lead to substantial annual property tax increases. Under California Proposition 13, the assessed value of real property is locked at acquisition and grows at a rate capped at 2% per year. However, transferring a property by gift, will, trust, or entity transfer typically triggers a change in ownership that resets the assessed value to current fair market value under Proposition 19 (effective February 16, 2021). The parent-child exclusion that historically protected these transfers is now limited: a child must occupy the property as their principal residence within one year of the transfer, and the excluded assessed value is capped at the parent’s prior assessed value plus $1 million (indexed). If the property is used as a rental, secondary home, or commercial space, reassessment is immediate and complete.
The math illustrates the impact. If parents purchased a Bay Area residential rental in 1985 for $500,000, and it has an assessed base of $1.1 million and a fair market value of $5 million, the annual property tax bill is approximately $12,000 (at a standard 1.1% rate). If the property passes to a child who keeps it as a rental, Proposition 19 resets the assessed value to $5 million. This increases the annual property tax bill to roughly $55,000, creating an ongoing $43,000 annual liability that outweighs the income-tax benefit of the basis step-up over any reasonable holding period.
To manage this reassessment exposure:
Hold the real property inside an LLC. Under California Revenue and Taxation Code §§ 64(c) and 64(d), property is only reassessed if a single buyer acquires more than 50% of the LLC’s voting control, or if original co-owners cumulatively transfer more than 50% of their initial interests. By structuring transfers of minority LLC interests over time, you can defer reassessment. The LLC must operate as a legitimate business entity with separate accounting, leases, and partnership tax filings.
If heirs do not intend to keep the property, selling it while the parent is alive triggers a one-time capital gains hit but avoids a permanent property tax reassessment. A tax-deferred exchange under IRC §1031, “Exchange of real property held for productive use or investment” defers income tax but does not carry over the Proposition 13 base: the replacement property is assessed at its purchase price.
To preserve the parent-child exclusion, the child must file a Homeowners’ Exemption (BOE-266) within twelve months of the transfer and reside in the property. Assessed value exceeding the prior base plus the $1 million exemption remains subject to reassessment.
Homeowners over age 55, severely disabled individuals, or victims of natural disasters can transfer their current Proposition 13 base assessed value to a replacement residence of any value anywhere in California up to three times. This benefit is limited to the parents’ lifetime and does not shield the next generation.
Transfers to grandchildren can qualify for the parent-child exclusion if the middle-generation parents are deceased at the time of the transfer.