Community Property

Group of people discussingWhile community property laws can vary from state to state, all community property states operate on the theory that both spouses contribute equally to the marriage and therefore, all property acquired during marriage is equally owned by both spouses. There are currently 10 community property states: Alaska (by election), Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington and Wisconsin. Puerto Rico also adopted the community property system.

Community property basics

Each community property state generally characterizes a married couple’s property as either “separate property” or “community property,” depending on when and how it was acquired. A person’s “separate property” is generally classified as all property either:

  • Acquired before marriage
  • Received as a gift or inheritance during marriage
  • Recovered for personal injuries sustained during marriage

A person’s “community property” is generally classified as property that was acquired by either spouse during marriage (other than separate property).

You can alter the character of property through spousal gifts or an agreement, like a pre- or post-nuptial agreement. It’s best to put these agreements in writing, although some states allow oral agreements.

If you move from a non-community property state (also known as a “common law state”) to a community property state, the property brought to the community property state will be treated as quasi-community property. Quasi-community property is treated like community property in most respects.

Some community property states will allow you to aggregate the value of community property automatically or by electing the aggregate theory of community property. Under the aggregate theory, each spouse owns one-half of the entire value of community property, rather than one-half of each individual piece of property (referred to as the “item theory” of community property). Aggregation can help simplify the administration of an estate upon your death or the death of your spouse, especially when you both own a large retirement asset.

Community property and debt

In community property states, you are generally considered to share debts with your spouse. Depending on the law, creditors may be able to reach all or part of your community property — regardless of how it is titled — to repay debts incurred by either of you. In some states, spouses may agree to divide the community property so that in the future it’s held only as separate property and only available to the creditors of one spouse.

Community property and divorce

The distinction between separate property and community property is especially important during a divorce. A person’s separate property remains with the owner of the separate property. Separate property is not divided between spouses.

The community property, including property located outside of the state, is typically divided between the couple. Each asset may not be divided equally, but the value of all community property is generally divided equally.

As provided above, most community property states consider property acquired in a common law state by a couple who moved to a community property state as “quasi-community property.” During a divorce, the court may also divide the value of quasi-community property equally between the spouses.

Community property in estate planning

For estate planning purposes, the distinction between separate property and community property is also important. At your death, you are usually entitled to leave your half of the community property to anyone you want. But the law provides that the other half is owned by the surviving spouse. In some states, community property must go through probate. In others, you can add the “right of survivorship” to your community property so that when one spouse dies, the other automatically owns the deceased spouse’s half of the couple’s community property, which avoids probate.

An advantage of keeping your community property status is that upon your death (or the death of your spouse), the property receives a full step-up in cost basis to its current fair market value. This is different from property in common law states, where only the decedent spouse’s one-half interest in jointly titled property receives a step-up in cost basis.

Interest in your spouse’s retirement plan

A surviving spouse’s retirement plan and/or IRA is generally subject to community property laws, but there are limitations. For instance, the surviving spouse’s interest in a plan may be protected by a federal law called the “Employee Retirement Income Securities Act” (ERISA). If the plan is subject to ERISA, federal law rather than state community property law determines each spouse’s share. The U.S. Supreme Court has ruled that a deceased spouse’s estate can’t distribute his or her community property interest in a surviving spouse’s ERISA plan.

Not all retirement plans are subject to ERISA. For these plans, the law is still somewhat unclear. If you want to distribute your community property interest in your surviving spouse’s plan upon your death, there may be income tax consequences of the transaction that you need to consider. For example, your surviving spouse may need to withdraw your share from the plan, pay income tax on the withdrawn amount, and then distribute the net amount to your estate for distribution. Consider working with a qualified estate planning attorney or tax advisor to discuss your options.

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