Imagine two business owners, married for twenty-five years, who built a company from a garage in Nashville into a seven-figure enterprise. Their LLC interest has a tax basis of almost nothing and a fair market value in the millions. If one of them dies tomorrow, the surviving spouse inherits a tax problem hiding inside a tax break: only half of that appreciation resets to today's value. The other half keeps its decades-old basis, and a future sale could trigger a capital gains bill in the hundreds of thousands of dollars.
Couples who happen to live in Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, or Wisconsin don't have this problem. Those nine states treat most marital assets as community property, and under IRC Section 1014(b)(6), the entire asset — not just the deceased spouse's half — gets a full basis step-up to fair market value when the first spouse dies. For business owners in the other 41 states, that's traditionally meant either accepting the partial step-up or physically relocating to a community property state.
There's a third option that's gained real traction over the past decade: a community property trust. Five states — Alaska, Tennessee, Kentucky, Florida, and South Dakota — now let married couples opt into community property treatment by moving assets into a specially drafted trust, without either spouse ever setting foot in the state.
How the Basis Step-Up Actually Works
To see why this matters, it helps to compare the three ownership structures side by side for a couple who bought an asset for $200,000 that's now worth $2 million.
| Ownership structure | Basis after first spouse's death | Capital gain if sold immediately after |
|---|---|---|
| Standard joint tenancy | $1.1 million (half steps up, half stays at original cost) | ~$900,000 taxable |
| Community property (resident of a community property state) | $2 million (full step-up) | $0 taxable |
| Community property trust (opt-in state) | $2 million (full step-up, per current planning consensus) | $0 taxable |
The mechanism is simple in concept: a community property trust is a joint revocable trust that both spouses fund with assets they agree to treat as community property. When the first spouse dies, the trust — not state residency — determines that the entire asset gets the Section 1014(b)(6) treatment, the same rule that already applies automatically in the nine community property states.
For a business owner, this distinction can be worth far more than it sounds. A surviving spouse who inherits a fully stepped-up LLC or partnership interest can sell the business, or specific business assets, with little or no capital gains tax due. Compare that to the alternative: liquidating half a business just to cover a tax bill triggered by the other half's stale basis.
Why the Entity Type Matters
Not every business interest gets the same treatment even with a full basis step-up, so it's worth knowing which structure you're actually holding:
- Partnerships and LLCs taxed as partnerships: A basis step-up at the entity level (an inside basis adjustment) generally requires a Section 754 election. Without it, the surviving spouse's outside basis in the LLC interest steps up, but the partnership's inside basis in its underlying assets doesn't automatically follow — which can create a mismatch that surprises people when the business later sells appreciated equipment or property.
- S corporations: The step-up applies to the basis of the shares themselves, not to the underlying corporate assets. S corps can't make a 754 election, so there's no equivalent inside-basis fix.
- Directly-held real estate or securities: The step-up applies cleanly to the asset itself with nothing else to coordinate.
This is exactly the kind of detail where a generic online trust template falls short — a community property trust holding an LLC interest usually needs to be paired with the right elections at the entity level to get the full tax benefit.
The Requirements — and the Real Uncertainty
Setting up a community property trust generally requires:
- A trust drafted under the law of one of the five opt-in states — Alaska, Tennessee, Kentucky, Florida, or South Dakota — usually with a qualified trustee or trust company in that state, even though the couple can live anywhere.
- Both spouses' consent to transmute the contributed property into community property, since separate property (inheritances, pre-marital assets, gifts to one spouse) doesn't automatically qualify.
- A revocable structure the couple can amend or unwind while both are living.
Here's the part that's easy to miss in the marketing copy: the IRS has never issued definitive guidance confirming that these opt-in trusts qualify for the full Section 1014(b)(6) step-up, and no court has ruled on the question for any of the five states. IRS Publication 555, which covers community property, doesn't address elective trusts at all. The planning community's consensus — based on the statute's plain language and the states' own community property statutes — is that these trusts should work exactly like community property in the nine native states. But "should work" and "has been tested" are different things, and anyone considering this strategy needs to hear that from their advisor up front, not discover it after the fact.
There's also a specific timing trap: IRC Section 1014(e) denies the step-up on appreciated property if the decedent received it as a gift within one year of death. If a couple funds a community property trust with one spouse's separate low-basis property and that spouse dies within a year, the step-up on that specific contribution can be disallowed. This isn't a reason to avoid the strategy — it's a reason to set it up well before it's needed, not as a deathbed maneuver.
Who This Is (and Isn't) a Good Fit For
A community property trust tends to make sense for couples who:
- Hold significant low-basis, highly appreciated assets — a business interest, investment real estate, or concentrated stock — that they intend to hold until death rather than sell during their lifetimes
- Have a stable marriage with low near-term divorce risk, since community property splits 50/50 on divorce just as it would in a native community property state
- Face limited creditor exposure, since a community property trust is not an asset protection vehicle — a creditor of either spouse may be able to reach that spouse's half, and joint creditors may reach the whole trust
It's a weaker fit for business owners in high-liability professions (contractors, medical practices, anyone who's been sued before), couples who might sell appreciated assets before either spouse dies (the benefit only materializes at death), or anyone whose marriage is on uncertain footing. A creditor who reaches trust assets while both spouses are alive erases the tax benefit entirely — the strategy only pays off if the appreciated assets are still there when someone dies.
The Bookkeeping Behind the Strategy
None of this works if the business can't document what it's actually claiming. A basis step-up is only as defensible as the basis you can prove existed the day before death — the original purchase price, capital contributions, prior depreciation, and any 754 adjustments already on the books. Couples who've kept clean, auditable records of contributions, distributions, and asset cost basis over the life of the business make this a straightforward conversation with their estate attorney and CPA. Couples who've relied on a patchwork of spreadsheets and bank statements often spend more on reconstructing basis history than they would have spent setting up the trust in the first place.
This is one more argument for keeping your business's financial history in a format that's easy to audit years or decades later. Plain-text accounting keeps every transaction, every capital contribution, and every basis adjustment in a version-controlled ledger you can hand to an estate attorney or CPA without a reconstruction project. Beancount.io gives you that transparency for free — no proprietary database, no vendor lock-in, just a clear, queryable record of exactly what your business owns and what it cost. Get started for free and make sure your books are ready for whatever your estate plan needs from them.