The short answer
Community property is the marital property system, used in nine states, under which property acquired by either spouse during the marriage while domiciled there generally belongs to both spouses equally, apart from separate property such as gifts, inheritances and property owned before marriage. IRS Publication 555 names the nine: Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington and Wisconsin. For exchanges it matters twice: under section 1014(b)(6) both halves can receive a new basis at the first spouse's death, and under Rev. Proc. 2002-69 an LLC owned only by the spouses as community property can be treated as a disregarded entity.
At a glance
| States | Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, Wisconsin |
|---|---|
| Basis at first death | Both halves generally take fair market value, if at least half is in the decedent's estate |
| Spouse-owned LLC | May be treated as disregarded or as a partnership, at the couple's choice |
| Exchange character | Property acquired in exchange for separate property generally stays separate |
State law creates the property; three federal rules decide how it is taxed.
IRS Publication 555 defines community property by state law: property acquired during the marriage while domiciled in a community property state, while property bought with separate funds 'or acquired in exchange for separate property' is separate. Registered domestic partners in California, Nevada and Washington generally follow the same rules.
Section 1014(b)(6) treats the surviving spouse's half of community property as acquired from the decedent if at least half of the community interest was included in the decedent's estate. Rev. Proc. 2002-69 says that when a business entity is wholly owned by spouses as community property and no one else is an owner, the IRS will accept the couple's treatment of it as a disregarded entity or as a partnership, and that a later change in reporting position is treated as a conversion of the entity.
A worked example from IRS Publication 551 shows the double step-up.
In IRS Publication 551, a couple owns community property with an $80,000 basis. At one spouse's death it is worth $100,000 and half is included in the estate. The survivor's half takes a $50,000 basis and the heirs' half also takes $50,000, so the whole property now carries the $100,000 value.
Applied to an exchange chain, that rule means a deferred gain built up over several exchanges can be eliminated on both halves at the first death, where a couple holding as joint tenants or tenants by the entirety would see only half adjusted. Run your own numbers with your CPA.
The rule has a condition. Section 1014(b)(6) applies only if at least half of the whole community interest was includible in the decedent's gross estate, and Publication 551 adds that this is so whether or not the estate must file a return. Records of how the property was acquired, and with whose funds, are what support the community character when the survivor later sells or exchanges.
It bites in vesting the replacement, in spouse-owned LLCs, and when separate property is mixed in.
Vesting the replacement as community property keeps the full basis adjustment available; vesting it as joint tenancy may not, depending on state law. Comparing the deferral against holding is covered in 1031 vs hold for step-up and swap till you drop planning.
If the relinquished property sits in a two-member LLC owned by the spouses, the choice under Rev. Proc. 2002-69 decides whether the couple or a partnership is the exchanger, so the replacement must be taken by the same party; see can an LLC do a 1031. Separate property exchanged during the marriage generally keeps its separate character, which matters in a later divorce; see 1031 exchange divorce planning.
Related questions
Can a couple outside the nine states get the double step-up?
Publication 555 covers spouses domiciled in the nine listed states, and section 1014(b)(6) turns on property held under community property laws. Owners elsewhere should not assume the double step-up applies and should have a tax adviser review how their state treats marital property.
Does a spouse-owned LLC have to file a partnership return?
Not if it is a qualified entity under Rev. Proc. 2002-69 and the couple treats it as disregarded. Switching later from one treatment to the other is treated as a conversion of the entity, so choose before the exchange starts.
Does the basis rule apply if no estate tax is due?
Yes. Publication 551 says at least half the value must be includible in the decedent's gross estate 'whether or not the estate must file a return'.
Sources
Checked against these publications on September 30, 2026. Rules and figures change; confirm the current version with your CPA or attorney before you act. This page is general information, not tax or legal advice.