Answering Frequently Asked Questions About Community Property

When it comes to estate planning, the state where you live — or have lived — can significantly impact your wealth transfer strategies. One of the most important factors to consider is whether the state follows community property laws. These laws, which apply in nine states, can affect everything from tax planning to how trusts are structured. Below we answer some of the most commonly asked questions about community property.

Q: What is community property?

A: Community property is a legal framework that determines how married couples own assets in certain states. Under this system, most property acquired during marriage is considered jointly owned by both spouses, regardless of whose name appears on the title or who earned the income to purchase it. This creates a presumption of equal ownership between spouses for marital assets.

Q: Which states follow community property laws?

A: Nine states currently follow community property laws:

• Arizona
• California
• Idaho
• Louisiana
• Nevada
• New Mexico
• Texas
• Washington
• Wisconsin

All other states follow separate property (or “common law”) systems, where ownership is typically determined by whose name is on the title or who purchased the asset.

Q: How does community property differ among states?

A: While all community property states share the basic principle of joint ownership during marriage, the specifics vary significantly. Key differences include:

• Income from separate property: Some states treat income generated from separate property (assets owned before marriage or received as gifts/inheritance) as community property, while others maintain it as separate property.
• Management rights: States differ in how spouses can manage community property assets.
• Creditor exposure: The extent to which creditors can reach community property varies by state.
• Quasi community property: Some states recognize property that was separate when acquired but is treated as community property upon divorce or death.

Q: What happens if I move between community property and separate property states?

A: Mobility between states can significantly impact your asset characterization:

• Moving from community property to separate property states: Generally, community property retains its character after the move, which can be advantageous for tax planning purposes.
• Moving from separate property to community property states: You may want to consider converting separate property to community property through a property agreement to access favorable tax benefits.

These changes may require adjustments to your estate planning documents and strategies.

Q: How is community property dealt with in a divorce?

A: In community property states, assets are typically divided equally (50/50) between spouses during divorce, as both spouses are considered equal owners of community property. This differs from separate property states, which use “equitable distribution,” meaning assets are divided fairly but not necessarily equally, based on various factors like length of marriage, contributions, and future needs.

Q: What are the tax advantages of community property?

A: Community property offers significant tax benefits, particularly regarding cost basis:

• Double step-up in basis: When the first spouse dies, both halves of community property assets receive a stepped-up basis to fair market value as of the date of death. This happens again when the second spouse dies.
• Capital gains savings: This double step-up can result in substantial capital gains tax savings compared to separate property, where only the deceased spouse’s share receives a stepped-up basis.

Q: Can I access community property benefits if I live in a separate property state?

A: Yes, several states offer community property trusts for non-residents:

• Florida
• Kentucky
• Alaska
• South Dakota
• Tennessee

These trusts allow residents of separate property states to hold assets as community property, potentially providing the double step-up in cost basis benefit without requiring a physical move to a community property state.

Q: What should I consider when planning with community property?

A: Key strategic considerations include:

• Property agreements: These can clarify or modify the characterization of assets as community or separate property.
• Gift planning: The community or separate nature of property affects gifting strategies and funding of trusts.
• Timing: Proper timing and legal representation are crucial when making changes to property characterization.
• State-specific rules: It is imperative to understand the nuances of your specific state’s community property laws.

Facing questions about community property laws? Reach out to Mari Berlin (Mari is licensed in Illinois and California), Stuart Kohn (Stuart is licensed in Illinois and Arizona), or another member of LP’s Trusts & Estates group.