Is Community Property a Raw Deal for your Estate Planning?
I am going to say two things that are somewhat contradictory. As an Estate Planning Attorney, most of my married clients are completely fine with owning their property as community property and they plan based on their assets being community property. This has to do with culture and custom. There is nothing intrinsically wrong with adults owning their property however they wish. However I personally do not like community property at all and kind of wish it would go away.
Community property (along with a wide range of things I do not like) won’t go away any time soon, so I guess we have to deal with it.
First of all, a definition is in order. Community property is property owned by a “community”- which is to say two people who are usually married but could also be registered domestic partners or cohabitants who agree to own property that way. The idea that everything you own through your skill, labor and effort is owned by the community. If you mow your neighbor’s lawn and your neighbor pays you $20, then $10 is essentially your spouse’s money. Perhaps more accurately 50% of every penny is community property. Since everything is shared, none of that $20 is really your own. If you use that $20 to buy a used couch from the garage sale across the street, then that couch is not completely your own. Half of it belongs to your spouse.
While it is nice to be married, I kind of like the idea of having my own stuff. Unless you get a gift or inheritance, you do not really get your own stuff.
Well this can be changed of course. People can get marital property agreements and change the nature of their property. They can agree to own their property the way they want. However community property is the default way to own things, and defaults are powerful things.
Another powerful force keeping property as community property, other than inertia, is the Tax Code. The US Tax code provides a remarkable benefit to couples that own their property as community property. Upon the death of a spouse, the deceased spouse (actually any deceased person) gets their property “Stepped up” when it comes to the basis calculation so that the heirs can typically get property without paying a capital gains tax. The unique benefit in having property owned as community property is that this rule applies to the community property owned by the surviving spouse as well.
So if that $20 couch appreciated in value to say $40 upon the death of the first spouse, the $10 increase for the deceased spouse’s share would not be subject to the capital gains tax. The increase attributable to the surviving spouse would not be subject to the capital gains tax ether, as it would also be “stepped up.” This is different from the result you might get if it were two unrelated people who partnered to own ½ a used couch each.
Some people would rather have their own used couch than have a step up in basis for their surviving spouse’s half after their death.
Another downside is that families are complicated things, or they often are. Some people get divorced; get into blended families and so forth. Community property ownership in some circumstances, and particularly when combined with other common arrangements, can be completely toxic and can lead to long-term bitterness and litigation.
If I had my way, and I don’t, people would just have their own stuff.