The are many variables in the particulars of property ownership styles across the states; however, some general rules apply in each case. Note that any state that’s not a community property state is a common-law state.
Kiplinger’s recent article entitled “How Community Property Trusts Can Benefit Married Couples” explains that community property states offer a distinct tax advantage for couples’ assets when a spouse dies. However, if you live in a common-law state, know that some states have passed statutes empowering married couples living in any common-law state to establish a community property trust with a qualified trustee. With this, they get a step-up in cost basis at each death, something not previously available in common-law states.
Under community property law, each member of a married couple owns one-half of all the property, with all the rights of ownership. Typically, all property acquired during a marriage is community property, except property acquired by gift or an inheritance.
Under federal income tax law, all community property (including both the decedent’s one-half interest in the community property and the surviving spouse’s one-half interest in the community property) receives a new basis at the death of the first spouse equal to its fair market value; in other words, the cost basis is stepped-up, and the assets may be sold without recognizing a capital gain.
Property only in the name of the second spouse to pass can receive a second step-up in basis, but there’s no second step-up for those assets that were placed into irrevocable trusts prior to the second death.
Under common law, married couples generally own assets either jointly or individually. When the first spouse dies, assets in the decedent spouse’s name, or in the name of a revocable trust, are stepped-up. Assets held jointly at death only receive a step-up in basis on half the property. And the assets in the surviving spouse’s sole name are not stepped-up. However, when the surviving spouse dies, assets held in his or her sole name can get a step-up in basis. Again, this doesn’t apply to assets placed into irrevocable trusts before death.
Right now, five common-law states have passed community property trust statutes that empower a married couple to convert common-law property into community property. They are Alaska, Florida, Kentucky, South Dakota, and Tennessee.
The purpose of community property trusts is to let married couples living in the resident state and others living in common-law states to also get a stepped-up basis up to all assets they own at the first death, just like in community property states. Residents who live in a common-law state that doesn’t offer this trust can still execute a community property trust in one of the community property trust states but must appoint a trustee in that state.
Reference: Kiplinger (Sep. 18, 2022) “How Community Property Trusts Can Benefit Married Couples”
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