What is community property, and what is a community property trust?
However, before we get into the details, let’s start with a few quick and easy definitions:
- Community property: Assets a married couple acquires by joint effort during marriage if they live in one of the nine community property states: Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin.
- Community property trust: A special type of joint revocable trust designed for couples who own low-basis assets, enabling them to take advantage of a double step-up. Tennessee or Alaska are the two places you can form these trusts, even for clients who do not live in those states.
Note: Differentiating between community property states and states in which community property trusts can be created can be a bit tricky. To put it simply, assets acquired jointly during marriage within those nine states are automatically considered community property. However, in Tennessee and Alaska, married couples can create a special trust called a community property trust. This trust effectively opts your clients into the same benefits that couples automatically enjoy in those states, at least for assets transferred into these trusts.
As you already know, assets are given a new basis when transferred by inheritance (through a will or trust) and are revalued as of the date of the owner’s death. If an asset has appreciated above its basis (what the owner paid for it), the new basis is called a stepped-up basis. A stepped-up basis can save a considerable amount of capital gains tax when the new owner later sells an asset. After implementing a community property trust, the entire value of the property gets a basis step-up when one of the spouses dies, hence the term double step-up (rather than only one-half of the property receiving the adjustment, which is what usually happens with jointly owned assets). So if a surviving spouse sells community property, the double stepped-up basis on the entire property can significantly reduce or even eliminate the capital gains tax.