Estate Planning for Community Property

Estate Planning can be different for married couples who live in the eight community property states. The one-third of Americans who live in those states need to take their state laws into account and make a few adjustments from traditional estate plans.

Community property laws say that property acquired before the marriage and inheritances are the separate property of each spouse. But all other property acquired during the marriage is jointly owned, regardless of who earned it or managed it.

That means if no adjustments are made, each spouse is treated as half owner of most of the couple’s property, regardless of the legal title. Upon the death of the first spouse, half of the assets will be included in estate of that spouse and will pass automatically to the surviving spouse.

That can be an estate planning advantage. Couples don’t have to worry about re-titling assets to ensure that each has enough assets to take advantage of the lifetime estate and gift tax exemption.

There also is a special tax break. In other states, I discourage couples from owning property jointly. That’s because after the first spouse passes, half the value of the property is included in the estate of that spouse. The surviving spouse takes title to that half and increases the tax basis to its fair market value. The other half of the property retains its initial basis.

That means if the surviving spouse wants to sell the property, the inherited half will be sold for no gain, making it income tax free. The other half will be sold at a gain. If the surviving spouse gives the property to someone, that person takes the same basis the surviving spouse had.

For residents of a community property state, however, the basis of the entire jointly-owned property is increased to its fair market value after the first spouse passes away. The surviving spouse can sell the entire property tax free at that point. If it is given to someone, that person can sell it without paying taxes on any of the appreciation that occurred during the first spouse’s lifetime. This treatment applies to all jointly-owned property, not just a personal residence. This rule can provide substantial tax breaks for investment portfolios and other valuable assets of those in community property states.

Married couples aren’t locked into these rules. The law merely creates a presumption. Residents of community property states can change the status of property by written agreement. A married couple can decide which property will be treated as separate and which will be community. Yet, they won’t have to officially re-title the assets.

The real trick of community property states is moving to or from one.
A couple moving from a community property state can preserve the community property status of assets. For example, if a couple sells a home in a community property state and moves to a common law state, usually they can have the deed written so that the house retains its community property status. This also can be done with most other assets.

Couples who move from other states to community property states need to meet with an estate planning profesional who is savvy about community property. They need to learn which of their property now will be presumed to be community property. They also have to decide to what extent they want to write an agreement defining separate property and community property differently than the law defines it. Handling this transition properly can result in thousands of dollars of income and estate tax savings in the future.

Much of the estate planning advice you see is based on common law states. Residents of the community property states, and those who are considering moving to them, need to learn the unique features of community property law.