Separate v. Community Property, Basis, and Step-up

Disclaimer: This blog post is for informational purposes only and does not constitute legal advice. Laws change frequently and there is no guarantee that the information in this post will be applicable or correct when you read this. You should consult with an attorney to discuss your specific situation.

Separate Property vs. Community Property

Separate Property

Separate property is any asset you owned before your marriage, or which you received during the marriage as a gift or inheritance. The key characteristic is that you own it individually.

  • Treatment in a Trust: When you transfer separate property into a living trust, it generally remains designated as your separate property unless you take specific legal steps to "commingle" it or change its character through a legal process called “transmutation.” This is typically designated in the trust document itself.

  • Separate property can become community property if the spouse whose names not on the deed/title/ownership document contributes to the mortgage, interest, taxes, or otherwise contribute to the marriage in other ways. It is vital to speak to a licensed family law attorney to gain clarify and to protect the separate character of your property if that is your wish. The consequences of holding assets as separate v. community property in the event of a divorce is beyond the scope of this article and is within the expertise of a family law attorney.

Community Property

Community property is generally defined as any asset that you and your spouse acquired together during your marriage while domiciled in a community property state. Both spouses own an undivided 50% interest in all community property assets.

  • Treatment in a Trust: For married couples, placing community property into a joint living trust is a standard practice. The trust holds the property for the benefit of both spouses, and the community property character is usually maintained.

Step-Up in Basis and Tax Implications

The step-up in basis is one of the most significant tax advantages of holding property as community property, particularly for assets like real estate or stock portfolios that have appreciated significantly in value.

What is "Basis"?

Your basis is essentially the original cost you paid for an asset, plus the cost of any significant improvements. This figure is used to calculate the capital gain (or loss) when the asset is sold.

How the "Step-Up" Works

Under federal tax law, when a person dies, the basis of their assets is "stepped up" (or down) to the asset's Fair Market Value (FMV) as of the date of death. This significantly reduces the capital gains tax your heirs will pay if they sell the asset shortly thereafter.

  • Separate Property Rule (Half Step-Up): If an asset is the separate property of the deceased spouse, only the deceased spouse's half interest in the asset receives a step-up in basis. The surviving spouse's half retains its original, lower basis.

  • Community Property Rule (Full Step-Up): If an asset is community property, the entire asset (both the deceased spouse's half and the surviving spouse's half) receives a full step-up in basis to the FMV at the date of death. This is often called a "double step-up."

Disclaimer: This blog post is for informational purposes only and does not constitute legal advice. Laws change frequently and there is no guarantee that the information in this post will be applicable or correct when you read this. You should consult with an attorney to discuss your specific situation.