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Property Ownership
Is the Grass Greener on the Other Side? Community Property vs. Separate Property
Estate Planner Jul-Aug 2000
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When it comes to community property, ignorance is not bliss. Whether you live in a community property state or a separate property state, you need to know how each system works. (See "Community Property States" on page 4.) It is important to understand not only how your state treats property you acquired while living in another state, but also how other states would treat your property.

The property rules of other states may easily affect you at some point in your life. If you have ever lived in another state, own real estate in another state, have plans to move to another state or if your parents live in another state, you should understand that the rules regarding property ownership can help you reduce taxes and pass on more to your children.

And understanding other states' property rules is even more important now that it appears you no longer need to simply accept the system your state has created to govern your property. Alaska state law provides a mechanism by which you can choose to have your property treated as community property even if you live in a separate property state.

These property rules affect both premarital agreements and estate plans. Let's take a closer look at issues to consider when owning community property or separate property.

Tax Effects Of Community Property

The basic premise of community property is that if a couple acquires property during a marriage, each spouse owns one-half of the property. The practical effect is that each spouse can dispose of only one-half of the community property at his or her death. During life, a spouse may be required to obtain the other spouse's consent to sell or make gifts of community property.

Holding community property can offer significant federal tax advantages. For example, when one spouse dies, the surviving spouse and the decedent's estate each receive an adjusted tax basis for all of the community property. (In most cases this will be an increase, but the adjustment is tied to federal estate tax values and could result in a decrease.)

The practical effect in most cases is that capital gain on all of the community property is erased as of the date of death of the first spouse to die. The surviving spouse or the estate can then sell any of the property without incurring capital gain. In contrast, in a separate property state only the property owned by the decedent receives a step-up in basis.

Consider an Alternative

You do not necessarily need to follow the property system established by your state of residence or the state in which you purchase real estate. For instance, you may elect out of community property treatment if you reside in a community property state to avoid having to obtain the other spouse's consent to sell or make gifts of community property. If you move from a community property state to a separate property state, you may choose to retain the community property nature of your assets. But to do this, you need to ensure the community property is not mixed with separate property -- otherwise, you could lose community property status.

How can you do this? You may want to establish a joint trust to hold the community property upon moving to the new state or simply prepare an agreement outlining the status of the assets as community property. But you must ensure that the assets remain segregated.

Another alternative is to leave assets in the community property state in a custody account which provides that the account is governed by the laws of the community property state. It may be possible to retain the community property nature of the assets by simply segregating them from other assets upon arriving in the new state, but the estate planning documents that dispose of the segregated assets should provide for the disposition of only one-half of the assets at the death of each spouse.

Undertake similar planning if you have separate property that you wish to remain separate when you move to a community property state. You should consciously decide how your property will be treated.

If you are interested in obtaining the tax advantages of community property and don't mind its limitations but don't reside in a community property state, then consider trying to take advantage of the Alaskan system, which allows nonresidents to convert property to community property. Note that implementing such a decision is complex, involves placing property in trust, and requires careful planning and coordination by your advisor.

Understand the Rules

If you live in either a community property state or a separate property state, you need to know how your state will treat the property you acquired while living in another state and how other states will treat your property. These property rules may affect both premarital and estate planning. Seek professional advice to learn the rules governing your community or separate property.