The Ultimate Tax Advantage: How a California Revocable Trust Delivers the Double Step-Up in Basis
Disclaimer: This information is for educational purposes only and is not legal advice. You should consult with a qualified attorney to discuss your specific situation. The law is complex and constantly evolving.
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For married couples in California, an updated estate plan is not just about avoiding probate—it’s about locking in a powerful, multi-million dollar tax advantage. That advantage is the Double Step-Up in Basis.
If you own highly appreciated assets like real estate, investments, or a family business, correctly structuring your revocable living trust could save your heirs a fortune in capital gains taxes.
Here is why this strategy is uniquely beneficial in California and how recent law changes, particularly Proposition 19, make strategic planning more critical than ever.
What is the Step-Up in Basis and Why Does it Matter?
When you buy an asset, its purchase price is called its cost basis. If you sell that asset later for a higher price, the difference is your capital gain, which is taxable.
However, federal tax law offers a major break for inherited assets: the Step-Up in Basis.
When a person dies, the tax basis of their assets is "stepped up" (reset) to the asset's Fair Market Value (FMV) on the date of death.
The appreciation (growth) that occurred during the decedent's lifetime is entirely wiped clean, and your heirs can sell the asset with little or no capital gains tax.
Example: You bought a property for $200,000 (your basis). When you die, it's worth $1,200,000. If your heir sells it for $1,200,000, their taxable capital gain is zero, not $1,000,000.
The California Community Property Advantage: The DOUBLE Step-Up
This is where California’s community property laws elevate the tax savings for married couples.
California is one of only nine community property states. Generally, any asset acquired during the marriage is considered equally owned by both spouses. The IRS rules state that when one spouse dies, both halves of the community property receive a full step-up in basis.
This creates the Double Step-Up:
First Spouse Dies: When one spouse dies, both the deceased spouse's half and the surviving spouse's half of the community property receive a full step-up in basis.
Second Spouse Dies: When the surviving spouse eventually dies, the entire asset (now owned 100% by the survivor) receives a second step-up in basis to the FMV at that time.
This double elimination of capital gains is a massive benefit that can preserve millions of dollars in wealth for the next generation.
Your Revocable Trust: The Key to Locking It In
To ensure your assets qualify for this crucial benefit, your estate plan must be properly structured.
1. Titling is Everything
Many California couples mistakenly title their property in Joint Tenancy. If an asset is held in joint tenancy, only the deceased spouse's 50% interest receives the step-up. The surviving spouse’s original 50% interest retains the old, low cost basis, resulting in a large future tax liability.
A properly drafted Revocable Living Trust holds the assets and clearly designates them as Community Property. This ensures that upon the first death, the entire asset receives the full step-up.
2. Avoiding Old Tax Traps (A-B Trusts)
If you have an older trust (written before 2011), it may contain A-B Trust or Bypass Trust provisions designed to minimize old federal estate taxes. While beneficial at the time, these structures often cause assets in the "B" (Bypass) Trust to lose the second step-up when the surviving spouse dies.
An experienced estate planning attorney can review and update an old trust to ensure it utilizes modern strategies, often referred to as a Disclaimer Trust, that prioritize the Double Step-Up while still offering federal estate tax protection if needed.
⚠️ The Prop 19 Connection: Don't Confuse Tax Savings
It is vital to understand that the Double Step-Up in Basis (which saves on federal and state capital gains tax) is completely separate from the new rules under California Proposition 19 (which affects annual property tax reassessment).
Step-Up in Basis (Good): Saves your heirs money when they sell the property.
Proposition 19 (Challenging): Often causes a property tax reassessment when the property is transferred to your children, resulting in a much higher annual tax bill.
The Crucial Intersection
You can successfully execute the Double Step-Up strategy (saving capital gains tax) and still face a property tax reassessment under Proposition 19.
The Post-Prop 19 Reality:
Non-Primary Residence: If you leave rental properties, vacation homes, or commercial properties to your children, they will be immediately reassessed at their current market value, and the new, higher property taxes will apply.
Primary Residence Exception: Your children can only retain your low property tax base on your primary residence if one of them moves in and makes it their own primary residence within one year. Even then, there may be a partial reassessment if the market value is significantly higher than the protected base value plus the indexed exclusion amount (currently over $1 million).
The Takeaway
The Revocable Living Trust remains the cornerstone of modern California estate planning for married couples. It is the necessary legal tool to properly classify your assets as Community Property and ensure your family receives the lucrative Double Step-Up in Basis, providing massive tax savings upon the eventual sale of appreciated property.
However, the recent changes under Proposition 19 mean that simply having a trust is no longer enough. You need to work with an attorney who understands how to balance these two distinct but equally important tax landscapes to give your family the best possible outcome.
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Disclaimer: This information is for educational purposes only and is not legal advice. You should consult with a qualified attorney to discuss your specific situation. The law is complex and constantly evolving.
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