The Florida Community Property Trust Act, signed into law on July 1, 2021, provides that assets transferred by a married couple to a community property trust will be treated as community property while owned by the trust.
You may be reading this blog post because you have heard of community property trusts and may be interested in the federal income tax benefit enjoyed by community property assets. If so, you have come to the right place.
But what is community property and why would a Florida couple be interested in a community property trust? This article is intended to address each of those questions in turn.
What is Community Property?
The two marital property systems in the United States are separate property (also known as the common law system) and community property. Nine states—Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin—have adopted the community property regime, and the other 41 states (including Florida) are on the separate property side of the fence. However, Alaska, South Dakota, Tennessee, Kentucky, and most recently Florida permit couples to elect into a community property regime through a community property trust.
In separate property states, property acquired during marriage is generally deemed to be the separate property of the spouse who acquired it (but special rules usually apply to property divisions on divorce). The community property system, on the other hand, manifests the social and legal belief that property acquired by spouses during marriage should be construed as one total “community” of property. Generally speaking, all property acquired (and income earned) during marriage is owned one-half by each spouse regardless of how title to the property is taken. On divorce or death, there is a partition of the community property and each spouse (or the predeceasing spouse’s estate in the event of death) is vested with his or her one-half interest.
The separate or community property classification of a particular asset is determined at the time the asset is acquired in accordance with the laws of the state in which the couple was domiciled when acquired. An asset’s original classification is generally thought to not be altered when the couple later moves to a different state—that is, the character of property generally follows the couple as they move from state to state (except in the case of quasi-community property, which is recognized in community property states as separate property that would have been community property if acquired in that state in order to protect a non-owner spouse upon a property division).
Why Would Florida Spouses Want a Community Property Trust?
A community property trust potentially offers a valuable tax benefit by allowing a couple to convert their assets to community property. From a federal income tax perspective, community property benefits from a “double basis step-up” at death under Section 1014(b)(6) of the Code. At death, property included in a decedent’s estate obtains a new tax basis equal to the property’s fair market value, which may be higher or lower than its basis (referred to as a “basis step-up” with appreciated property and a “basis step-down” with depreciated property). While only the predeceasing spouse’s one-half of the community property is included in his or her estate for federal estate tax purposes, the entire community property interest is adjusted to fair market value at the death of the predeceasing spouse. Note that depreciated community property assets will receive a double basis step-down on the death of the first spouse.
To illustrate this tax benefit, assume a Texas husband and wife own Apple stock with a cost basis of $100 and a value of $1,000. At the husband’s death, the husband bequeaths the stock to his wife, who will now have a new basis in the stock equal to $1,000 and could turn around and sell the stock with no taxable gain. Now assume the same facts except the married couple resides in Florida and the Apple stock is owned as joint tenants with rights of survivorship. At the husband’s death, his wife obtains a new basis in the stock equal only to $550, which represents the wife’s $50 share of the stock’s original basis (i.e., $100 times 50%) plus the husband’s $500 share which was included in his estate and eligible for a basis step-up. Here, the wife would have a $450 taxable gain if she were to sell the stock.
There are important issues to consider before transferring assets to a Florida community property trust, and the conversion of assets to community property is advisable only in certain situations. For example, a future creditor’s ability to attach the assets transferred to a community property trust may differ than if the same assets were instead owned as tenants by the entireties or by one spouse’s name outside of the trust. Further, a spouse’s rights during marriage and upon divorce or death in assets held in community property trust may differ than if held outside the trust. Finally, it’s not clear if the Internal Revenue Service will respect the community property classification of assets in a community property trust.
Chris Weeg prepares Florida community property trusts for clients throughout the State of Florida. You can reach Mr. Weeg or the estate planning department’s attorneys at Comiter, Singer, Baseman & Braun, LLP at (561) 626-2101.