Updated January 16, 2019
Hershner Hunter, LLP
Estate and Business Planning Practice Group
What it means for couples moving from a community property state
If the married couple has appreciated (or appreciating) assets, the preservation of the community property nature of their assets is an important goal with potentially significant tax advantages that should not go ignored, and these advantages can be lost if the couple unintentionally destroys the community property nature of their assets. Creating a community property trust is an important component for preserving community property.
Why Community Property Matters: New Basis At Death for Surviving Spouse’s Interest
Although there are other benefits to owning assets as community property, the major reason we care about community property from a planning perspective is that it impacts the basis in assets of the married couple for tax purposes. Generally, most assets of a deceased person receive a new basis equal to the fair market value of the assets at the time of the decedent’s death. With community property, at the death of the first spouse, the new basis applies not only to the decedent spouse’s half of the community property, but also to the surviving spouse’s half of the community property.
It is difficult to overstate the potential benefit of the readjusted basis for both the decedent’s half interest and the surviving spouse’s half interest in their community property. For example, if a brokerage account with 5,000 highly appreciated shares of stock is held as community property of both husband and wife, and husband passes away, husband’s 2,500 shares get a new basis as of the date of his death, but so do surviving wife’s 2,500 shares. Alternatively, if the property is not community property, only husband’s 2,500 shares get a new basis.
The obvious initial impact is that a sale of surviving wife’s shares at that time would no longer cause recognition of any gain. However, there are other planning opportunities to consider. An investment portfolio with highly concentrated positions can be rebalanced and diversified without concern for recognizing gain. A credit shelter trust created at the death of the first spouse has greater flexibility to be funded with both the decedent and the surviving spouse’s interests in an asset, such as a jointly-owned brokerage account, without recognizing gain. Also, where one spouse has a partnership interest that is community property, the new basis for both spouses’ interests would apply if there is an election under IRC §754.
The ability to get a new basis for both halves of the community assets on the first death is likely to be a significant estate planning goal for the couple. This is even more important with the impact of recent changes in the tax code, including the 2.3% tax on net investment income, and the adoption of a 20% rate bracket on capital gains for certain taxpayers.
What Assets are Community Property
Assets acquired by a married couple during marriage while living in a community property state are community property, including income earned by either spouse. There are exceptions for gifts or inheritances received by a single spouse. The separate property of each spouse that is brought into the marriage remains separate property.
Generally, proceeds of community property are community property. This means that an asset that otherwise might not qualify as community property could nevertheless become community property, if the funds used to purchase the newly-acquired asset can be traced back to community property.
If a married couple moves from a community property state to Oregon, employment income earned after the move and assets acquired with that income are not community property. The issue of concern discussed here is the treatment of community property assets already held by the couple before the move to Oregon.
Oregon law allows couples to keep marital assets as community property and the concept of tracing the source of an asset to community property can allow a couple living in Oregon to continue to acquire community property, for example, using income earned while living in a community property state, or proceeds from the sale of a home located in a community property state. However, a couple might still unintentionally jeopardize the community property nature of the assets if they are not careful. Married couples should work with their financial and legal advisors on actions to take to protect the community property status of property.
How to Preserve Community Property in Oregon
When a married couple with community property moves to a non-community property state, the manner in which the couple takes title to an asset while living in Oregon often will determine whether the asset will continue to be, or become, community property.
There are potential problems, both legal and practical, for couples who attempt to preserve community property in Oregon by taking title to an asset in one spouse’s name only, in both names with right of survivorship, or using some special declaration of community property ownership by the individuals. The IRS has previously recognized a revocable living trust that preserves the community property characteristics of property contributed to the trust. This makes a “community property trust” the best option in our opinion for preserving community property in Oregon.
The community property trust must have specific terms and provisions in order to protect the community property nature of the assets in the trust. A typical Oregon joint trust for couples without community property does not have the appropriate terms to function as a community property trust. Special care must be taken when preparing trusts for community property assets.
Many of the couples we work with who have community property come from California and already have a community property trust. Usually the trust has all the required elements, but couples should have the trust agreement reviewed to be certain it complies with the IRS requirements, since some practitioners in California rely on California’s trust code to cover any gaps.
While Oregon is not a community property state, its geographic location mandates that advisors be aware of the basic nature of community property. The new basis at death for community property can be tremendously advantageous for clients with appreciated assets. Likewise, the loss of community property status for a couple’s assets could result in significant taxes that might otherwise have been unnecessary.
If you have questions, please contact any member of The Estate and Business Planning Practice Group.
This article provides general information and should not be construed as legal advice or a legal opinion on any specific facts or circumstances. If you have specific legal questions, you are urged to consult with counsel concerning your own situation.