Step-Up in Basis for Trust Property in California: Complete Guide
California living trust property receives a full step-up in cost basis to fair market value on the date of the grantor's death. This means heirs and beneficiaries pay capital gains tax only on appreciation occurring after the date of death, not on the property's full lifetime appreciation. For highly appreciated California real estate, this can eliminate hundreds of thousands of dollars in tax liability.
The stepped-up basis rule (Internal Revenue Code Section 1014) applies to property acquired from a decedent. For a California living trust, the property is considered acquired from the grantor at the time of the grantor's death. The basis is reset to the property's fair market value on that date, regardless of what the grantor paid for it, how long they owned it, or how much it appreciated during their lifetime.
Establishing the stepped-up basis requires documentation of the property's fair market value on the date of death. The IRS accepts several forms of evidence, but a professional appraisal by a licensed appraiser is the most defensible. The appraisal should be specifically dated as of the date of death, not a current appraisal done months later. Keep this appraisal permanently; you may need it years later if the property is sold and the IRS questions the reported basis.
The tax savings from the stepped-up basis can be extraordinary. Consider a home purchased in Beverly Hills in 1980 for $250,000, worth $4.5 million at the grantor's death. Without the stepped-up basis, the capital gain would be $4.25 million, subject to federal capital gains rates of up to 20% plus California's income tax rate of up to 13.3%. With the stepped-up basis, a sale at $4.5 million generates zero taxable gain.
Community property held in a California living trust may receive a double step-up, meaning both halves of the community property receive the stepped-up basis when the first spouse dies, even though only one spouse died. This is a significant advantage of holding community property in a California living trust compared to holding it in joint tenancy. Consult a CPA about whether your specific trust structure qualifies for the double step-up.
The stepped-up basis is available for property held in a revocable living trust, not an irrevocable trust. Property transferred to an irrevocable trust during the grantor's lifetime may not receive the step-up, because it is no longer considered the grantor's property at death. This is an important distinction in estate planning; consult an attorney before transferring property to an irrevocable trust.
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