Here in Nevada, we live in a community property state. There are 8 other states with community property laws, primarily in the west. In addition to Nevada, they are Washington, Idaho, California, Arizona, New Mexico, Texas, Louisiana, and Wisconsin. The rest are separate property states, often referred to as common law states.
Many of the separate property states recognize a form of property ownership known as tenancy-by-the-entirety. This is very similar to joint tenancy, except that it may only be held by a married couple. Some states only allow this form a ownership for real property, while others also include investment accounts. One nice feature of tenants-by-the-entirety is that is takes both spouses, acting together, to encumber property. This can provide a certain level of asset protection.
Another aspect of a common law state has to do with a spousal election. When the first spouse dies, states that allow a spouse to elect against the will of the deceased spouse, often allow the election against about 1/3 of the probate estate. Some states allow the election against what is known as an augmented estate, which adds non-probate assets to the probate estate. Basically, the spousal election prevents one spouse from disinheriting the other spouse.
Community property states don’t have either tenancy-by-the-entirety nor spousal elections. The idea in a community property state is that each spouse enjoys equally in the fruits of the other’s labors so that each spouse has a one-half ownership interest in all of the assets that are the product of the labor. In Nevada, as in many community property states, there is a presumption that property which is acquired during the marriage is community property. That is unless it can be proved that the asset was owned prior to marriage by one of the spouses. Other exceptions include showing that the property was received by one of the spouses as a gift or inheritance or that there is an agreement to the contrary.
To determine if an asset is community or separate property, you must look not only at the domicile of the parties, but also the source of the funds used to acquire it. How the assets are titled is not determinative. This can be confusing for people. For example, if George and Mary live in Nevada and George receives a paycheck that he deposits into a bank account held in his name only, those funds are still community property. And if George uses that money to purchase a new car titled in his name alone, the car is also community property. In other words, there is a tracing component to community property.
Stepped Up Basis
One nice income tax advantage to community property is the full stepped up basis. In a separate property state, it is common for the married couple to hold property as joint tenants. For capital gains tax purposes, when one spouse dies there is a basis adjustment only on the deceased spouse’s half of the property. However, in a community property state there is a stepped up basis on the entire property, not just one-half. Then when the surviving spouse passes away, the property may receive another basis step-up. It should be noted that the basis could be adjusted downward depending upon the fair market value of the property on the date of death.
From an estate planning point of view, it is very common for married couples with community property to establish one joint revocable trust. If a spouse also owns separate property, he or she may desire to also set up a trust for the separate property. Either way, it is important for the estate planning attorney to know what is community and what is separate property. This will better inform the discussion between the attorney and the client as to what plan options will best achieve the clients’ goals.