Married MLP investors in 9 states get BOTH halves of their portfolio stepped up at first death — not just the decedent’s half. For a 5-MLP portfolio held 15 years, that’s an extra $19,703 in federal tax eliminated, plus up to $21,579 more in California state tax. Here’s the math, the edge cases, and the 7-item checklist.
By Lucas Andersen — Masters in Finance, proprietary energy trader, direct MLP holder (Washington state, community property)
Last updated:
Key Takeaways
When my wife and I moved to Washington, I wasn’t thinking about community property law. But Washington’s community property status may be the single most valuable feature of our MLP portfolio. When one of us dies, ALL of our MLP units step up to fair market value under §1014(b)(6) — not half. In New York, only the decedent’s half would step up. In Washington, the surviving spouse’s half steps up too, even though the surviving spouse is still alive.
For background, see When Step-Up Basis Beats a Trust and MLPs in a Living Trust. This article is the deep dive on one specific benefit: the dollar value of the §1014(b)(6) community property double step-up, computed per state for a real 5-MLP portfolio.
Common-law states: jointly held MLPs receive §1014 step-up only on the decedent’s interest. Community property states under §1014(b)(6): both halves step up at first death — the surviving spouse’s half (which they still own outright) 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. For MLPs with 15+ years of basis erosion, the surviving spouse in a common-law state is still stuck with near-zero basis on their half; in a CP state, both halves reset to full FMV.
The nine CP states: Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, Wisconsin. Alaska allows opt-in community property; Tennessee and South Dakota allow community property trusts for non-residents.
| Line item | Community Property | Common Law |
|---|---|---|
| Portfolio FMV at Y15 first death | $164,770 | $164,770 |
| Combined eroded basis at Y15 | $2,521 | $2,521 |
| Decedent’s half stepped up? | Yes | Yes |
| Surviving spouse’s half stepped up? | Yes (§1014(b)(6)) | No |
| Basis after step-up | $164,770 | $83,646 |
| Federal tax eliminated | $39,406 | $19,703 |
| §751 recapture eliminated | $84,000 | $42,000 |
| Surviving spouse’s remaining deferred tax | $0 | $19,703 |
| CP advantage at first death | +$19,703 federal tax eliminated | |
| State | Top Rate | Federal Elim. | State Elim. | Combined |
|---|---|---|---|---|
| Texas | 0% | $39,406 | $0 | $39,406 |
| Washington | 0% | $39,406 | $0 | $39,406 |
| Nevada | 0% | $39,406 | $0 | $39,406 |
| Arizona | 2.5% | $39,406 | $4,056 | $43,462 |
| Louisiana | 4.25% | $39,406 | $6,896 | $46,302 |
| Idaho | 5.695% | $39,406 | $9,232 | $48,638 |
| New Mexico | 5.9% | $39,406 | $9,573 | $48,979 |
| Wisconsin | 7.65% | $39,406 | $12,412 | $51,818 |
| California | 13.3% | $39,406 | $21,579 | $60,985 |
California MLP investors benefit MORE from the double step-up than any other state — because the step-up eliminates state deferred tax as well as federal. Counterintuitively, California’s high state tax rate makes the §1014(b)(6) step-up more valuable, not less.
Canonical 5-MLP portfolio, community property state, two-death cycle: Y1–15 collected $166,659 in distributions at $16,721 tax. Y15 first death eliminates $39,406 federal deferred tax + $84,000 §751. Y16–30 surviving spouse collects another $166,659 at $10,234 tax. Y30 second death eliminates $54,329 federal + $84,000 §751. 30-year totals: $333,318 distributions collected, $26,955 federal income tax paid, $93,735 in federal deferred tax eliminated via two step-ups, $168,000 in §751 exposure wiped out, children inherit $276,047 with fresh basis. Total §751 recapture paid by anyone in the family: $0.
Five edge cases: (1) MLPs bought before marriage are separate property. (2) MLPs bought with inherited or gifted funds may be separate. (3) Prenups/postnups can classify assets as separate. (4) MLPs purchased in a common-law state don’t automatically convert when you move to a CP state. (5) Separate brokerage accounts don’t automatically make assets separate property. Classification matters for §1014(b)(6) eligibility — clarify while both spouses are alive.
Two benefits combine at first death: (1) §2056 unlimited marital deduction — community property passing to a U.S.-citizen surviving spouse qualifies for zero federal estate tax, regardless of size. (2) §1014(b)(6) double step-up — both halves reset to FMV, eliminating all accumulated deferred income tax and §751. Combined: zero estate tax AND zero embedded income tax on the MLP portfolio at first death. The surviving spouse receives the full portfolio at fresh basis with no tax liability of any kind. This combination does not exist for any other asset class under current US tax law.
California’s 13.3% top state rate is the highest in the country, applied to MLP K-1 income at ordinary rates (no preferential LTCG treatment). Same 5-MLP portfolio at first death: Texas eliminates $39,406 federal + $0 state = $39,406 total. California eliminates $39,406 federal + $21,579 state = $60,985 total. The state with the highest income tax rate offers the biggest benefit from the §1014(b)(6) step-up.
Texas combines community property status (double step-up), no state income tax (zero state deferred tax accumulation), and concentration of midstream energy investors. No cleaner structural setup for married MLP investors exists under current US tax law. Washington state offers the same two structural advantages.
Coming soon: What happens when a US community property state resident holds MLPs and one spouse is a non-resident alien — §2056(d) QDOT requirements and treaty-based spousal transfers.