Estate Planning in a Community Property State
Washington is one of only 10 community property states in the United States. The community property system of ownership has several unique features that can affect a married couple’s estate plan. This post provides a quick refresher on the basics of community property law as it pertains to estate planning.
Community property is the default system of ownership available to a married couple in Washington. Couples might execute a prenuptial agreement to opt out of the system or change the default rules to better suit their needs. Absent a pre-or post-nuptial agreement, the basic rule is that all property acquired by either spouse during the course of their marriage is community property. This means the property belongs one-half to each spouse, regardless of whose name may appear on title to the property. Spouses share equal rights to manage community property. Married persons may still own separate property: generally, any property acquired before the marriage remains the owner spouse’s separate property, and the owner spouse individually manages his or her separate property. Property received by gift or inheritance will also remain the recipient spouse’s separate property, even if the gift or inheritance is received during marriage, as long as the inherited property is not commingled with community property.
When it comes to cost basis, property characterized as community property may receive an extra “perk” with a potential increase in value. Cost basis is the acquisition cost of a particular asset, and is used to calculate capital gain or loss when an asset is sold. Assets that pass via inheritance usually get a new cost basis equal to the fair market value of the asset on the decedent’s date of death. It’s common to say “stepped up” basis because assets may increase in value over time. The “stepped up” basis is equal to the fair market value at date of death, which may be higher (or in some cases, lower) than the decedent’s original acquisition cost. Basis also takes into consideration things like capital improvements and depreciation.
One beneficial aspect of a couple owning community property is that as long as at least half of the community property is included in the decedent spouse’s estate, federal tax law allows the entire community including the surviving spouse’s half to obtain a stepped up basis.
There are also, however, some potential drawbacks to converting what would otherwise be separate property of the spouses into community property. In the event of a divorce or dissolution of marriage, although courts have authority to divide and distribute all property as they deem equitable, the owner of property retained as separate property generally has a much greater chance to retain all or a greater share of his or her separate property. Once separate property is converted to community property, however, that characterization is likely to be confirmed by the court. This is just one potential impact of converting what would otherwise be separate property into community property.
Married couples and individuals contemplating marriage should familiarize themselves with the basics of community property.
Contact a member of the Stokes Lawrence Estate Planning practice if you have questions regarding how community property law affects your planning.