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Common law versus community property law

The U.S. has two property systems for married couples, common law, and community property law. In a common law state a married person is a separate individual with separate legal rights to property and separate tax obligations. Common law states are also called “separate property” states.

There are nine community property states: Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin. Alaska and Florida are ‘opt-in’ community property states that give both parties the option to make their property community property. Two states, Alaska, and Tennessee, allow non-residents to establish a community property trust with a trustee in their state.

How do I know if my property is separate or community?

In a separate property state, you cannot create community property. Property of one spouse or the other is presumptively that person’s separate property. Community property is created when a married couple residing in a community property state acquires property during the marriage. In a community property state, the law treats a married couple much like it treats partners, each spouse owns an undivided one-half interest in the “community.” In a community property state, titling is not always determinative of ownership.

Think about this!

On the first death, a deceased spouse can very simply pass their share of the community property to their spouse. A deceased spouse can also force the division of community property by making a gift in their will of their one-half interest in the community property to someone who is not their spouse.

The tax basis of community property adjusts to fair market value on the death of the first spouse, leaving both the surviving spouse’s share and the deceased spouse’s share with a basis adjustment. Assets can be sold after death without capital gains exposure. When property is jointly held in a separate property state, only the decedent’s one-half share gets a basis adjustment to fair market value. Only one-half of the sale of these assets avoids capital gains exposure.

Be aware when moving from state to state

Once property is defined as community property, it retains its character as community property for tax purposes and for many legal purposes. Legal applications may include treatment on divorce or separation, transfers on death, obligations for debts and liabilities. If a married couple moves from a community property state to a separate property state, most state laws allow you to preserve your community property. You will need advice from a knowledgeable lawyer to determine if you want to preserve your community property rights and instructions for how to do so. They will also help you title your property to accomplish your goals.

At Wool Landon, we have spoken extensively on these issues. We help clients understand the value of preserving community property when moving from a community property state to a separate property state, such as moving from California or Washington to Oregon. Equally important, if you move from a separate property state to a community property state, such as from Oregon to Arizona or California, you may benefit from electing to convert some or all your property from separate property to community property.

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