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This Article is designed to be of general interest. The specific techniques and information discussed may not apply to you. Before acting on any matter contained herein, you should consult with your personal adviser.
In general, Community Property is everything earned during
marriage from efforts performed during marriage.
Anything owned prior to marriage (and the proceeds and
reinvestments of such property) is Separate Property.
Gifts and inheritances received during marriage are also
For Divorce Court purposes, property is converted from separate
to community by a husband and wife placing title in Joint
Tenancy or Community Property. Mixing property (commingling)
generally causes conversion into Community Property.
INCOME TAX CONSEQUENCES OF DEATH ON BASIS
Community Property has a major advantage after one spouse has
"Step Up in Basis"
The income tax valuation ("basis") of inherited assets is the
value on the date of death.
For example, if Uncle George leaves you a share of stock
in XYZ, and the stock was selling for $250 per share at
the time of George's death, that share is treated if you
had purchased it for $250 whenever you eventually sell the
George's actual cost of the stock is totally
disregarded for all future purposes.
If value has decreased, a step down in basis occurs.
Joint Tenancy Property gets HALF a Step Up in Basis
If you and George had purchased that share of stock together,
when it cost $50, your cost basis for your ½ share was $25, and
George's cost basis for his ½ was $25. George dies and leaves
you his ½ share. Only the portion inherited receives the step
up in basis.
You now have your old ½ with a cost basis of $25, and George's ½ with a new basis of $125 (its value on the date
of his death). Your total basis is $150. If you sell it right away for $250,
your taxable profit is $100.
Community Property gets a "FULL Step Up in Basis"
A special rule applies to Community Property. Regardless of
which spouse dies first, the entire 100% of Community Property
is revalued at the date of death of the first to die.
In our example, if you are married to George, and the stock is
Community Property, the survivor's basis is $250 at the death
of the first spouse, regardless of who first bought that stock.
For Step Up in Basis, Signed Document is Needed
For Divorce Court purposes, there are different rules to
determine status of property. For tax purposes (i.e. step up
in basis) property must be titled Community Property or another
document signed by both spouses is needed. [For property owned
from before 1984, an oral agreement between the spouses may be
sufficient, but a written document is better proof.]
THERE IS A DOWN-SIDE TO CONVERTING ASSETS INTO COMMUNITY
BENEFITS OF KEEPING PROPERTY SEPARATE
If property is separate (and Community Property can easily be
made separate, by a written agreement of both spouses) there
are two possible advantages.
Separate Property has an advantage since it is not subject to
claims of all of the spouse's separate creditors. It is
subject to claims for "community debts" (debts incurred for the
family's general benefit, generally including business debts
incurred during marriage), but not for pre-marriage debt or
debt in connection with separate property (such as a tenant at
his separate rental unit sues).
If property is already owned in Joint Tenancy, conversion to
Community Property has no ramifications if a future divorce
occurs since each already owns half.
Declining Value Assets: Step Down in Basis
If George bought IBM at 105 and it is now at 60, if you inherit
that stock you take with it the date of death fair market value
as your basis. Thus you cannot write off that loss from
George's original cost. [In fact, George should have sold the
stock before he died so he could write off the loss.] If the
property is owned as Separate Property, at George's death it
gets half a step down in basis; if it is held as Community
Property, it gets a full step down.
Better planning would be for George to sell that stock, take
the loss, and buy it back (he must wait at least 30 days before
buying it back to be able to write off the loss).
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