What is community property and why should you care? Unless you moved to Florida from Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington or Wisconsin (which are the “original” community property states), you likely have never heard of community property or own any assets which would be treated as such. However, as a result of a new law which was recently passed in Florida and became effective on July 1, 2021, known as the “Florida Community Property Trust Act,” all Florida residents should acquaint themselves with the concept of community property and be aware of the significant income tax benefits which can arise from owning community property.
So what is community property? Community property is a marital property system governing ownership of assets between a married couple during their marriage and in the event of the two big “Ds” – death and divorce. Community property is unique in that each spouse is treated as owning an undivided one-half interest in the assets, meaning that any assets acquired during the marriage (with a few exceptions) are viewed as being owned by both spouses regardless of how those assets are titled or which spouse acquired them. This is in contrast to non-community property jurisdictions, which provide that title is determinative of ownership (i.e., property titled in one spouse’s name is presumed to be that spouse’s separate property).
While Florida is not historically a community property law state, the new Florida Community Property Trust Act allows married couples to elect to treat assets as “community property” by transferring them to a Florida Community Property Trust (“CPT”). This means that Florida residents (and non-residents if certain requirements are met) may now acquire community property if the married couple hold assets in a CPT which is properly prepared under the new Florida law.
Now that we have bored you with a brief legal lesson regarding community property, we will get to the good stuff – the potential tax savings if you create a CPT and own community property in your new trust. Community property enjoys a significant income tax benefit because applicable federal tax laws provide that the basis of all of the community property, regardless of which spouse owned or acquired the assets and notwithstanding the order of the spouses’ deaths, is adjusted to the fair market value of the assets as of date of death of the spouse first to die (the “step-up” in basis rule). Historically in Florida, when the first spouse died, only the assets in that spouse’s name received a step-up in basis to the date-of-death value. By way of example, if all of the couple’s assets were owned in Wife’s individual name and Husband passes away, none of the property would receive a step-up in basis. Assets owned jointly with the surviving spouse would receive the step-up in basis as to one-half of the value of the property. Under the new Florida Community Property Trust Act, if a married couple properly creates and funds a CPT, all of the assets held in the CPT will be community property and receive a full step-up in basis (sometimes referred to as a “double step-up”) to the fair market value as of the date of the first spouse’s death, resulting in all unrealized gain in the property being eliminated. This provides the surviving spouse with added flexibility, as he or she would be able to sell any some or all of the CPT assets without incurring capital gains tax. As a result, if a CPT is established by the married couple, the tax burden on the surviving spouse would likely be significant lower than if the couple did not implement the community property trust planning.
The final question you may be asking is who would benefit from CPT planning. The answer is that any married couple who own appreciated assets should consider using this type of trust. Typically, the couple would be in a long-term and stable marriage, have relatively equal property ownership (i.e., all of the assets are not in one spouse’s name alone), and there are no present or foreseeable creditor concerns. A married couple who has (1) highly appreciated property which could benefit from the double step-up in basis, (2) an over-weighted financial portfolio which has not been diversified to avoid paying capital gains tax, or (3) rental or investment real estate (which may have been heavily depreciated and have a low or negative cost basis) that the surviving spouse would have no interest in managing, could significantly benefit from this type of planning. Also, since the new Florida Act permits homestead property to be held in a CPT, many Florida couples are electing to transfer their primary Florida residence to a CPT since many times this is the couple’s most valuable asset and there is substantial unrealized gain on the residence due to the hot real estate market in Florida.
You should consult your attorney if you are interested in discussing this brand new estate planning strategy. Your surviving spouse and beneficiaries will thank you!