Many states today are known as Community Property States. They include Arizona, California, Washington, Idaho, New Mexico, Louisiana, Wisconsin, Nevada and Texas.
What is interesting is this type of ownership actually derived from Spanish Civil Law, from the early influence of Spanish settlements in America. So if you’re a resident of one of these states then community property laws will apply.
1. Money earned by either spouse during marriage and all property bought with those earnings.
2. All debts incurred during marriage are generally debts of the couple. Under community property, spouses own – and owe – everything equally, regardless of who earns or spends the income.
Also, pre-marriage debts remain separate property. For example, educational loans acquired before a marriage wouldn’t become community property.
But separate property can transform into community property. For example, if a spouse who owns property before the marriage adds the new spouse’s name to the deed, that home becomes community property.
So what is the main benefit of holding assets in Community Property?
It has to do with how property steps up at death. Normally in a non-community property state, if one spouse passes away and there is an appreciated asset such as real estate or stock, the cost basis, or what you originally paid for it, would get a 50% step up when the first spouse passes away. Not with Community property, the asset would get a 100% step or double step up at the first passing.
This can have huge tax ramifications for clients that have farm property, real estate, stock, or business holdings that have appreciated significantly over time. The surviving spouse can sell the asset and avoid paying tax on all of the gains that had built up prior to the decedent’s spouses passing.
This can open up additional planning opportunities, such as repositioning assets that may be necessary for the surviving spouse, capturing gains in appreciated assets as well as an opportunity to better position an estate to pass on to the remaining beneficiaries.
What if I don’t live in a community property state?
For those of you in states that are not community property states you can set up a Community Property Trust in Alaska or Tennessee even if you are not a resident of those states. Once this trust is set up and property is transferred into the trust, it will have all of the benefits of community Property.
Are you holding title to real estate as joint tenancy in a community property state?
What if you live in a community property state but hold real estate as joint tenancy with right of survivorship? Generally if it is a home you would lose the step up of the entire amount and only half would step up on the first death. Now remember a primary residence will still have the $250,000 step up without capital gains tax per person, but in some cases there can still be capital gains tax if the surviving spouse sells the residence if the gain exceeds $250,000. If instead the property was titled as community property then there would be a full step in value no matter how large the gain.
For other real estate assets such as rentals or commercial property, there would be a loss of the 50% step up by holding the asset as joint tenancy instead of community property.
The only way that real estate titled as joint tenancy to receive the community property full step up would be it there was a document you had in writing that all property is to be considered community property.
What if only one spouse is listed on a brokerage account that had a large appreciation?
For this to receive the community property step-up, then there would need to be some proof that the stock shares were purchased within the community property marriage and that community property funds were used. Without this proof there is a good chance that the 100% step-up would not be recognized.
The Power of the Community Property Agreement within a Revocable Living Trust.
With this document all property is deemed to be community property even if the title doesn’t reflect community ownershipand there is only one spouse listed on an account. Most living trusts drawn up in community property
states will have this but make sure your does!
As you can see there are some very good benefits to community property ownership so make sure you take advantage of this even if your not in a community property state. If your not sure if your set up correctly reach out to your attorney or let us know and we can help you with details and also have attorney available who can draft and correct your documents.