In estate planning, the nature of the property involved can make a significant difference in determining the best way to plan for its ultimate disposition.
Community property, in states recognizing it, is a form of marital property which is derived from the labor of either party to a marriage. Community property is recognized in Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin. For example, if the wife receives a paycheck, it is community property. As such, it is really owned one-half by each of the members of the “community”, i.e., the marriage. This is the case even though the check may have been issued only to the wife and is sent to a checking account in her individual name.
This unique form of property can raise interesting opportunities and potential pitfalls when doing estate planning.
Upon your death, the “basis” in your property changes or “steps up” to the fair market value of the property at the date of your death. “Basis” is the benchmark for income taxation for the property. If the property is sold above that mark, there would be tax on that gain. In a non-community property state, a typical couple would hold property separately or as joint tenants with rights of survivorship. Either way, with rare exceptions, only one-half of the couple’s property qualifies for the favorable “step up” in basis. This is fair because only one-half is included in the estate of the spouse that has died.
However, with community property, the entire value of the property receives a step up in basis, even though only one-half of the property is included in the estate of the pre-deceasing spouse. This is a windfall for spouses in community property states. Most non-community property states will recognize community property created in another state. Accordingly, you should think twice, from a tax perspective, before severing community property.
If a person gives away some of their assets and retains certain powers over the property, it will still be taxed in his or her estate. When community property is involved, it can sometimes be confusing to identify whose property is whose. In our earlier example, one-half of the wife’s paycheck is really husband’s property, even though it is in an account with only wife’s name on it. Thus, when the couple decides to give away an asset, they must be quite careful to determine whose property it really is. If wife gives her property to a trust which she has set up and husband is trustee, it would not be included in either spouse’s estate if properly drafted. However, if husband’s property is placed in the same trust, it is likely it will be included in husband’s estate because he has control as trustee. So, if wife contributes her paycheck, there will be inclusion in husband’s estate because it is really one-half his!
As you have seen, community property can be a powerful tool but also can be quite tricky. A qualified estate planning attorney can help you determine if you have any community property and the best way to deal with that property.
Mr. Morrison is a board-certified estate planning attorney with experience in both simple and complex estate matters. We are members of the American Academy of Estate Planning Attorneys and offer guidance and advice to our clients in every area of estate planning. We offer comprehensive and personalized estate planning consultations. To learn more about how you can achieve your estate planning goals, please call (504) 831-2348 or visit our website at www.morrisonlawplc.com.