Finance Questions

Archive for the ‘Community Property’ Category

How is Community Property Treated At Death?

For example, if a married couple, Stanley and Iris, buy securities as "joint tenants with rights of survivorship" for $400,000, the IRS considers that each paid $200,000 for a one-half interest. If Stanley later dies, Iris automatically owns the entire account, and Stanley's one half of all the securities in their portfolio are revalued as of the date of his death. If the account was worth $1,500,000 when Stanley died, then Iris is treated as if she paid $950,000 for the securities -- computed by adding her share of the purchase price ($200,000), to the value of Stanley's share when he died ($750,000).
In contrast, the IRS treats "community property" as if it were owned completely by the deceased spouse, in applying this special "adjusted basis" rule. (For other purposes, such as computing estate taxes, only one-half of the value of community property is counted.) Therefore, if Stanley and Iris bought their securities as "community property" for $400,000 and Stanley later died, leaving his share to Iris, the entire account would be assigned a new "basis" at current fair market value. Threrfore, Iris's basis in the securities becomes $1,500,000.
The result is that if Iris decides to sell the "joint tenancy" property for $1,500,000 shortly after Stanley's death, she would realize a taxable capital gain of $550,000 (the $1,500,000 sale price minus her $950,000 "adjusted basis," computed two paragraphs above). If the same account were held as "community property," however, she would recognize no capital gain, because her "adjusted basis" would be the same as the sale price. Therefore, where spouses hold highly appreciated assets, the community property form is more favorable for capital gain tax purposes.
It is possible in some Community Property States for the spouses to change their respective ownership rights in an asset, from community property to separate property and vice-versa, simply by executing a written agreement to that effect. For example, in California, a couple with a joint tenancy with rights of survivorship account may simply append a note to their wills explaining that their intention is for their possessions, no matter how registered, to be considered community property. By doing this, the surviving spouse receives a full step-up in basis after the first spouse's death, while also retaining the convenience of holding the property in joint tenancy.
Since accounts held as community property are subject to probate, it might be advisable to hold community property in a trust account or a Totten trust (payable/transfer on death accounts), to avoid the probate process. Community property with right of survivorship accounts are allowed in Arizona and California.

What is Community Property?

Community Property is a form of property ownership, solely between husband and wife, recognized in community property states as follows:

• Arizona
• California
• Idaho
• Louisiana
• Nevada
• New Mexico
• Texas
• Washington
• Wisconsin
• Alaska (Adopted an optional community property system)

Specifics in law differ from state to state, but the defining feature of community property is this: irrespective of the name(s) on title documents, ownership of (almost) all property - including income from wages and self-employment - acquired or earned during marriage by either spouse is automatically split, so that each spouse owns a separate, undivided one-half interest.
Since the two equal interests of the spouses in community property are separate, each spouse is free to dispose of his/her half of community property in a will, subject to that state's spousal anti-disinheritance laws.
Community property does not automatically pass to the survivor; as it would if owned jointly, with right of survivorship in non-community property states. As a result, the deceased spouse's federal taxable estate contains his/her half of the couple's community property and will be subject to the probate process. Probate may be avoided by using a trust to hold community property assets.
If a couple lives, or has previously lived, in a community property state, he/she should be aware that some special rules apply to community property. Any property they may have acquired while living in one of these states may be considered community property when they no longer reside in a community property state. Since these rules vary widely from state to state, a client should consult with local counsel.
In community property states, property acquired by a spouse separately and brought into the marriage remains separate. In these states, too, property acquired by gift or inheritance, or in exchange for separate property or money, also remains separate. The income, if any, the separate property produces is treated differently among the community property states. As a practical matter, commingling of assets can obscure separate property ownership, until it finally becomes community property. This often happens with checking and other financial accounts.
For more information see IRS Publication 555, Community Property.