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Knowing When Community Property Laws Matter

Last update on: Apr 02 2019

Each state controls how estates within it are transferred and settled. That means there are 50 different estate laws in the U.S. (More when the territories are counted.) There are both major and minor differences between these laws.

There really are two very different major systems. One group of states uses community property laws, and the others don’t. The community property states are Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, Wisconsin, and, since 1998, Alaska. There are differences among the laws of community property states, but they have the same big picture principles.

In a community property state, each spouse in a married couple owns a present, equal, undivided interest in property or income acquired by either spouse during the marriage, and it’s called community property. Income from community property also is community property. It doesn’t matter if legal title is in only one spouse’s name or only one spouse earned income. It still is community property. Not included as community property is property owned before the marriage and property acquired during the marriage through gift or inheritance.

There are some other exceptions. For example, federal law generally overrides state law. That means retirement plans and Social Security benefits are controlled by federal law, not the community property law of the state.

Community property laws often are considered important only in case of a divorce, but they also play critical roles at other times.

In an estate, each spouse generally is entitled to half of the community property regardless what is in a will, trust, or other arrangement. Each spouse is free to dispose of the other half of the community property as he or she wishes. There is an income tax benefit to community property laws. When one spouse passes away, the basis of the entire property is stepped up to fair market value, though the surviving spouse owned half the property before and after the other spouse passed away. That allows the surviving spouse to avoid capital gains that can’t be done in non-community property states.

Of course, if you live in a community property state and have an estate planner who knows the laws, you aren’t likely to have an estate planning problem. Problems occur when people move from a community property state to a non-community property state. The community property nature of their assets continues. Some states have adopted a Uniform Act that addresses how property is handled when a couple moves from a community property state to a non-community property state. In other states, the estate planner has to decide how to handle the issue. Some do it well, while others make mistakes.

When you are married and moved from a community property state to a non-community property state, your estate plan needs to be revised. Your estate planner needs to know you used to live in a community property state. You should seek an estate planner who knows the effects of the move and how to deal with it in the plan. Some lawyers suggest the couple convert the community property to property owned as co-tenants. Doing this would lose the income tax benefit that comes from inheriting community property and might also reverse some of the rights and expectations the spouses had from the community property.

Instead, there are ways of confirming the community property nature of the property acquired in the other state and legally segregating the assets through documentation and perhaps separate accounts or trusts.

Community property laws also are significant when applying for some benefits, such as having Medicaid pay for long-term care. Medicare will pay for long-term care only when the recipient satisfies certain income and asset tests by essentially being impoverished. In non-community property states this can be done without impoverishing the other spouse. But in community property states, each spouse is considered to own half the assets and income of the other as long as they are married. It can be more difficult to qualify for this and other benefits in a community property state.

There are some important differences between community property and non-community property states. The differences can matter most when you move to or from a community property state. They also can matter when seeking some federal program benefits and in other instances.



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