Pros And Cons Of Community Property
Pros And Cons Of Community Property
Community property is a form of property ownership that applies to married couples or domestic partners in certain states.
It has several advantages and disadvantages that can significantly impact financial planning, estate planning, and asset protection.
Advantages Of Community Property
- Equal Ownership: In a community property regime, both partners are considered to equally own any property or asset gained after marriage or joining a domestic partnership. This includes real estate, wages, pensions, stock options or investments, and insurance.
- Full Step-Up in Basis: One of the significant tax benefits of community property is that the property receives a full step-up in basis. This means that if a couple purchased shares that were worth $100 and on the death of the first spouse, they’re worth $1,000, the new basis in the property will be $1,000. Thereby, the $900 appreciation goes away completely and will not be taxed.
- Protection for Surviving Spouse: Titling property as community property can be beneficial to surviving spouses, as their deceased spouse cannot dispose of more than 50% of the property. This ensures that the surviving spouse would be left with some assets, even if their deceased spouse disposed of their share of the assets to someone else.
Disadvantages Of Community Property
- Divorce: In the event of a divorce, community property would be split equally between the spouses. This could be a disadvantage for the spouse who earned the lion’s share of the income but still has to equally divide their assets with their spouse.
- Creditor Claims: Community property is considered fair game for liabilities, so creditors can come after the asset regardless of which spouse owes.
- Inheritance Issues: One of the pitfalls of community property is that if one spouse dies and leaves their half of a property to someone other than their surviving spouse, it can create complications. To prevent this, couples can claim title as community property with right of survivorship.
- Restrictions on Property Disposal: If the property was community property, one spouse could not make a gift or transfer real estate without the consent of the other spouse.
Estate Planning In Community Property States
Estate planning in community property states involves understanding the specific laws and regulations that govern the division of property in these states.
Nine states in the United States are community property states: Arizona, California, Idaho, Louisiana, New Mexico, Nevada, Texas, Washington, and Wisconsin. Alaska also allows you to elect into community property for property held in a community property trust.
In community property states, spouses who acquire property during marriage own property equally, 50/50. This means that one spouse on death can leave his or her share as he or she wants and on divorce, it typically is divided 50/50 as well.
Estate Planning Considerations In Community Property States
- Property Characterization: The first step in estate planning in community property states is identifying which assets are characterized as community property. Assets acquired during the marriage, including income, are typically considered community property. However, there are exceptions such as pre-marital assets, gifts received, and inheritances, which are usually considered separate property unless they are commingled with community property.
- Inheritance: Inheritance is generally not considered community property in California and most likely in other community property states as well. However, if the inherited funds are commingled with community property, it may change the characterization of the inheritance from separate to community property.
- Probate Process: Community property doesn’t always avoid probate. If a property is titled solely as “community property,” then it will still pass through probate because it indicates ownership interest but doesn’t indicate how the property should be conveyed in the case of the death of an owner. However, property owned in joint tenancy or community property with the right of survivorship can avoid probate. In these cases, if one of the spouses passes away, then the property would automatically pass to the surviving spouse.
- Survivorship Community Property: Holding property as survivorship community property has certain consequences. If you hold title as “community property with right of survivorship,” then when one spouse dies, the other will automatically own the community property. No probate process or probate court procedures will be necessary to make the transfer.
- Estate Planning for Couples Who Have Lived in Different States: If you’ve moved in and out of different states some of which were community property states and others not, the analysis could be quite complicated. You should provide complete information, and any supporting documents, to your estate planning attorney.
