Community Property and MLPs: The Double Step-Up Nobody Mentions

When my wife and I moved to Washington, I didn’t think about community property law. I was thinking about mountains, not tax code. But Washington’s community property status may be the single most valuable feature of our MLP portfolio — more valuable than any distribution increase, any unit-price appreciation, any individual ticker selection.

Here’s why. When one of us dies, ALL of our MLP units step up to fair market value under §1014(b)(6). Not half. All of them. In New York, only the decedent’s half would step up — the surviving spouse would keep the original eroded basis on their half. In Washington, the surviving spouse’s half steps up too, even though the surviving spouse is still alive.

For the canonical 5-MLP portfolio computed throughout this site, held 15 years, that is the difference between eliminating $19,703 in federal deferred tax and eliminating $39,406. Double. And if we lived in California instead, the community property step-up would also eliminate another ~$21,579 in California state tax — the same portfolio producing roughly $61,000 in combined federal and state tax eliminated versus ~$30,000 in a common-law California scenario.

This article is the deep dive on that specific benefit — the §1014(b)(6) double step-up — because no existing source has computed the per-state dollar value for a real MLP portfolio. For the broader argument on why step-up-at-death generally beats trust structures, see When Step-Up Basis Beats a Trust. For what your successor trustee needs to do on Day 1, see MLPs in a Living Trust.

In common-law states (the 41 non-community-property states plus DC), jointly held assets receive a §1014 step-up only on the decedent’s interest. If spouses hold 1,000 MLP units as joint tenants, 500 units step up at first death; the surviving spouse’s 500 units retain their original eroded basis.

In community property states under §1014(b)(6), both halves of community property step up at the first spouse’s death. The surviving spouse’s half — which they still own outright, did not inherit, and never gave up control of — receives a fresh basis as if they purchased those units at the date-of-death market price. This is the only provision in the Internal Revenue Code that adjusts the cost basis of property the living owner still holds.

Why this matters specifically for MLPs: basis erodes through distributions every single year. After 15 years on the canonical EPD/ET/MPLX/WES/PAA portfolio, combined adjusted basis has dropped from $98,350 to approximately $2,521 — a 97% erosion across both halves. In a common-law state, only half that eroded basis is reset. The surviving spouse is still stuck with roughly $1,260 of eroded basis on their half, which means every distribution they subsequently collect bleeds that half toward zero-basis §731 territory — and if they ever sell, their half still carries the full §751 recapture accumulation. In a community property state, both halves reset. The surviving spouse walks away with a completely clean portfolio.

Married couple, canonical 5-MLP portfolio (EPD 1,000 / ET 500 / MPLX 500 / WES 300 / PAA 500), held 15 years as joint property, first spouse dies. Same portfolio, same erosion, same Year-15 FMV. Different state.

The $19,703 is only the federal number. The community property double-step also resets state-level basis. For states that tax MLP K-1 income, the step-up eliminates state-level deferred tax liability at the same rate the state would have charged on sale.

State tax eliminated applies the top marginal state income tax rate to the $162,249 of embedded gain (the difference between stepped-up basis and eroded basis). State rates shown are top marginal ordinary income rates; many states tax long-term capital gains at the same rate as ordinary income (unlike the federal system), which is why the full embedded gain is used. Federal tax eliminated from the engine computation (§751 ordinary + LTCG with NIIT). Common-law-state equivalents would cut every “state tax eliminated” cell roughly in half at first death.

California MLP investors benefit more from the double step-up than investors in any other state — because the step-up eliminates state deferred tax as well as federal. The same portfolio that saves $39,406 in Washington or Texas saves $60,985 in California. High state tax rates make the §1014(b)(6) step-up more valuable, not less.

The community property advantage compounds across two deaths. Here is what a 30-year generational hold looks like for the canonical 5-MLP portfolio in a CP state, engine-computed end-to-end.

Across 30 years and two deaths, the portfolio collected $333,318 in cash distributions, paid only $26,955 in federal income tax on those distributions (an 8.1% effective rate), and eliminated $93,735 in deferred federal income tax via two step-ups, plus $168,000 in §751 ordinary-income recapture exposure. The children inherit $276,047 with a fresh basis and zero embedded tax. Total §751 recapture actually paid by anyone in the family: $0.

A common-law-state couple following the identical hold strategy ends up at roughly the same destination at the second death — because the second death steps up everything regardless of state. The CP advantage matters most between the two deaths: the surviving spouse in a CP state has full-FMV basis across all units, which means more flexibility to rebalance, sell individual positions, take larger distributions, or fund retirement spending without tripping §731 or §751. In a CL state, the surviving spouse is locked into hold-forever on their own half, because selling triggers the deferred tax the step-up didn’t clear.

Not everything a married person owns in a community property state is automatically community property. Five situations where it gets complicated:

1. MLPs purchased before marriage. Separate property remains separate even after years of marriage in a community property state. The EPD units you bought at 28, before you met your spouse, stay separate property unless you’ve affirmatively converted them.
2. MLPs purchased with separate funds. Inheritance, gifts, and assets traceable to pre-marriage funds are generally separate property. If your spouse inherited $40,000 and used it to buy EPD during the marriage, those units may be separate property — depending on whether the funds were commingled.
3. Prenuptial or postnuptial agreements. If your marital agreement classifies certain assets as separate property, §1014(b)(6) only applies to assets the agreement leaves as community property.
4. Moved between state types. MLPs purchased while you lived in New York don’t automatically convert to community property when you move to Washington. Some CP states recognize “quasi-community property” at death for pre-move assets, but the rules vary by state. This is attorney territory.
5. Separate brokerage accounts. Having separate accounts does not automatically make the assets separate property. In a CP state, assets acquired during marriage with community funds are community property regardless of which spouse’s name is on the account. Conversely, a joint account doesn’t make assets community property in a common-law state.

If your classification is ambiguous on any MLP position, get it clarified now, while both spouses are alive and can sign a transmutation agreement. Establishing community property status after death is significantly harder and may require probate litigation.

Tennessee and South Dakota allow residents of any state to establish a community property trust. For a married couple living in a common law state, this opens a path to the §1014(b)(6) double step-up without relocating:

• A married couple in New York, Florida, or Illinois establishes a South Dakota community property trust.
• MLP positions are transferred into the trust.
• Trust assets are treated as community property under South Dakota law.
• At first death, BOTH halves receive §1014(b)(6) step-up — same as a Washington or Texas couple holding directly.

This is sophisticated planning. It requires a South Dakota (or Tennessee) trustee and ongoing trust administration — typically $1,000–$3,000/year depending on the trustee and complexity. Weigh that annual cost against the potential double-step-up savings from the state ranking table above. For a large MLP portfolio with significant basis erosion, the math often favors the community property trust; for smaller portfolios, it typically does not. Consult a trust attorney experienced in community property trusts before acting.

A specific, numbered, printable checklist for married MLP investors in community property states. Items 1–4 you can do yourself. Items 5–7 need an attorney or CPA.

Items 1–3 take less than an hour. Item 6 costs $500–$1,500 with an attorney. The potential tax savings on a canonical 5-MLP portfolio is roughly $19,703 in federal tax plus up to $21,579 in California state tax at first death. For larger portfolios, the savings scale proportionally. This is the best-ROI estate planning action most married MLP investors can take this year.

Two separate benefits combine at first death for community property MLP holders, and most planning conversations treat them separately. They shouldn’t.

• §2056 unlimited marital deduction. Community property passing to a surviving U.S.-citizen spouse qualifies for the unlimited marital deduction. No federal estate tax at first death, regardless of portfolio size.
• §1014(b)(6) double step-up. Both halves of the community property portfolio receive a fresh basis at FMV. All accumulated federal and state deferred income tax, and all §751 recapture exposure, are eliminated on both halves.

Combined result at first death: zero federal estate tax, zero embedded federal income tax on the MLP positions, zero §751 recapture exposure, zero state deferred income tax (in CA/ID/LA/NM/WI/AZ — applicable portion), fresh FMV basis, and continuing distributions from every position. The surviving spouse holds a completely reset portfolio with full liquidity and no embedded tax liability.

The §2056 marital deduction matters primarily for estates above the current federal exemption ($15M per individual from 2026, permanent under the OBBBA, indexed). For most couples, the estate-tax piece is not the binding constraint. But the conceptual point stands: at first death, community property MLP investors face zero tax of any kind on the estate side and zero embedded income tax on the MLP side. This combination does not exist for any other asset class under current US tax law.

California deserves special attention because the math is different from every other community property state. California’s top state income tax rate is 13.3% — the highest in the country — and California taxes MLP K-1 income at the state level at ordinary rates (no preferential LTCG treatment). This means California MLP investors accumulate state-level deferred tax liability in parallel with federal deferred tax, year after year.

When the community property double step-up applies at first death, it eliminates all four layers simultaneously: federal deferred income tax, federal §751 recapture, California state deferred income tax, and California state §751 recapture (California conforms to federal §751 treatment in most respects, though specific conformity should be verified with a California CPA).

Paradoxically, the state with the highest income tax rate offers the biggest benefit from the community property step-up. California MLP investors who hold through first death eliminate more deferred tax, in absolute dollar terms, than investors in any other state. A California CPA who understands this dynamic can redirect clients away from mid-life MLP sales (which realize the California state tax liability) toward the generational hold strategy (which eliminates it).

Texas occupies an unusual structural position for married MLP investors. Three features combine:

• Community property state (full §1014(b)(6) double step-up at first death).
• No state income tax (zero state-level deferred tax accumulation, zero state tax on any eventual realization).
• Concentration of midstream energy industry and the retail investor base that comes with it.

A married MLP investor in Texas faces no state income tax during their lifetime and receives full elimination of both spouses’ federal deferred tax and §751 recapture at first death. There is no cleaner structural setup for MLP investing under current US tax law. The only planning addition needed is an explicit successor-trustee plan and proper community property titling on the brokerage account.

Washington state — where the author holds positions — offers the same two structural advantages (community property + no state income tax). The choice between Texas and Washington for an MLP investor is about climate, career, family, and cost of living — the tax structure is effectively identical. California offers community property with a materially higher state-tax burden during life, offset by a materially larger dollar benefit from the step-up at first death.

Coming soon: What happens when a US community property state resident holds MLPs and one spouse is a non-resident alien — §2056(d) qualified domestic trust (QDOT) requirements, §1014(b)(6) interaction with treaty-based spousal transfers, and the Norwegian tax treatment of an inherited stepped-up US partnership interest.