Do You Need a Community Property Trust? What Couples in Separate Property States Should Know

Legally speaking, there are two different ways married couples can own property. It all depends on where you live. There are:

• Separate property states (also known as common law)
• and community property states

In community property states, property acquired by a couple during marriage is considered to be jointly owned 50/50 by both spouses, regardless of whose name appears on the title or whose income was used to purchase the property. But in separate property states, marital assets aren’t automatically considered community property.

Couples who live in separate property states may experience financial benefits from setting up a community property trust. Here’s what you need to know:

Common Law vs. Community Property States

In community property states, each spouse owns one-half of the property. As of this writing, nine states are community property states:

1. Arizona
2. California
3. Idaho
4. Louisiana
5. Nevada
6. New Mexico
7. Texas
8. Washington
9. Wisconsin

All other states are separate property states. In these states, ownership is determined by whose name appears on the title or who purchased the property.

Married couples with highly-appreciated property who live in separate property states might consider putting their assets in a community property trust, which can offer significant tax advantages.

What is a Community Property Trust?

Some separate property states allow married couples to transfer ownership of property to a community property trust. Transferring ownership to a community property trust gives the married couple the benefit of community property ownership for that asset.

Five states allow married couples to create community property trusts:

1. Alaska
2. Florida
3. Kentucky
4. South Dakota
5. Tennessee

Benefits of a Community Property Trust

The main benefit of community property is a double step-up in basis. When one spouse passes away, both halves of the community property receive a step-up in basis to fair market value as of the date of death. When the second spouse passes away, the community property receives a second step-up in basis to fair market value.

In a separate property state, only the deceased spouse’s share of the property receives a step-up in basis. The surviving spouse’s share keeps its original cost basis.

How a Community Property Trust Works

Sally and Martin are a couple who have been married for decades. They live in the state of Florida, which is a separate property state. Many years ago, they jointly purchased a property to rent out and generate extra income. The cost (tax basis) of this property was $200,000.

Martin passed away before Sally. At the time of his death, the fair market value of their rental property was $1,000,000. Sally passed away a few years later and the fair market value of the property at the time of her death was $1,200,000.

If they placed the rental property in a community property trust, they would’ve received a double step-up in basis. The tax basis would step up to $1,000,000 upon Martin’s death and $1,200,000 upon Sally’s death.

If they did not place the rental property in a community property trust, they would’ve received a half step-up in basis upon the first spouse’s death. The tax basis would’ve stepped up to $600,000 upon Martin’s death. The deceased spouse’s stepped-up basis of $500,000 (50% of $1,000,000) plus the surviving spouse’s original basis of $100,000 (50% of $200,000) equals $600,000. The basis would’ve then stepped up to $1,200,000 upon Sally’s death.

If Sally wanted to sell the rental property after Martin passed away, she would’ve faced $400,000 in capital gains ($1,000,000 fair market value minus the $600,000 basis) if the property was not held in the community property trust. If instead, they placed the property in a community property trust before Martin passed away, Sally could’ve sold the home for $1,000,000 and not been on the hook for any capital gains taxes.

If Sally wanted to sell the property following her husband’s death and the property was in a community property trust, she would’ve had more money to spend in her remaining years and more money to pass along to her beneficiaries when she passed away.

When to Put Assets in a Community Property Trust

A community property trust may be beneficial for married couples with one or more low-basis assets they intend to keep until one of them passes away.

Assembly Wealth recently helped a couple with low-basis rental properties set up a community property trust. The older spouse is in declining health, and the younger spouse does not want to manage the properties after her husband passes away. With a community property trust, the younger spouse will receive a full step-up in basis upon her husband’s death. She will then be able to sell the low-basis properties without the accompanying headache of a substantial tax bill.

Depending on where you live, a community property trust may not be necessary. For example, in a community property state like California, a community property trust is typically not needed because state law already grants community property rights. Holding the asset in a simple joint revocable trust or standard titling of the asset is sufficient.

Community Property Trusts and Estate Planning

A community property trust should not be viewed as a replacement for essential estate planning documents such as a will or power of attorney. It can be one piece of a comprehensive estate plan.

Work with a financial advisor to determine if a community property trust is a good fit for your financial situation. Contact us online or give us a call at (415) 541-7774.

Related Reading:

• The Smart Way to Leave Assets to Your Heirs
• How to Talk to Your Family About Your Estate Plan
• Estate Planning: How to Avoid Common Pitfalls and Costly Problems

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Assembly Wealth (“Assembly”) is an SEC registered investment adviser; however, this does not imply any level of skill or training and no inference of such should be made. The opinions expressed herein are as of the date of publication and are provided for informational purposes only. Content will not be updated after publication and should not be considered current after the publication date. We provide historical content for transparency purposes only. All opinions are subject to change without notice and due to changes in the market or economic conditions may not necessarily come to pass. Mention of a security should not be considered a recommendation or solicitation to purchase or sell the security, and any securities mentioned may be held by Assembly for client portfolios. 

The client example above reflects the experience of a particular client and is provided for illustrative purposes only. Estate planning strategies and the resulting tax or probate savings depend on each client's unique financial circumstances, applicable law, and individual objectives. There is no guarantee that other clients will achieve similar results.

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