When it comes to how asset ownership is treated in a marriage, states are either considered “common law” or “community property.” In common law states, property belongs to the person titled on the asset, such as a deed or account holder. If both spouses’ names are listed as the asset owners, then the property is owned by both spouses. However, 10 states treat such assets as “community property,” where both parties share equal ownership of the property or earnings.
Community property laws can vary from state to state. However, all community property states treat property acquired during marriage is equally owned by both spouses. It is important to understand the laws of your state, especially in case of divorce and death.
Community property states generally characterize a married couple’s property as either “separate property” or “community property” depending on when and how it was acquired.
A person’s “separate property” is generally classified as all property:
A person’s “community property” is generally classified as property that does not qualify as separate property and which was acquired by either spouse during marriage. If you move from common-law state to a community property state, the property brought to the community property state will be treated as quasi-community property. Quasi-community property is treated differently from state to state, so it’s imperative to get good legal advice to ensure you understand your property rights.
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Some community property states will allow you to aggregate the value of community property. With aggregation, each spouse is treated as owning one-half of the entire value of the community property, rather than one-half of each individual piece of the property. This results in simpler administration of an estate at the death of the first spouse, especially when the couple owns a large retirement asset.
In community property states, you are generally considered to share debts with your spouse. Depending on the law, creditors may be able to reach all or part of your community property regardless of how it is titled to repay debts incurred by either spouse. In some states, spouses may agree to divide the community property so that, in the future, it is held only as separate property and only available to the creditors of one spouse.
The distinction between separate property and community property is especially important during a divorce. A person’s separate property remains with its individual owner. Separate property is not divided between spouses. Your community property, however, including property located outside of the state, is typically divided between the two of you. Each asset may not be divided equally, but the value of all community property is generally divided equally.
In the case of quasi-community property, the court may also divide the value of the property equally between divorcing spouses. Again, this varies from state to state, so consult your estate planning attorney to determine how the laws of your state apply to your situation.
The differences between separate property and community property are also important for estate planning. At your death, you are usually entitled to leave your half of the community property to anyone you wish. But the law provides that the other half is owned by the surviving spouse. In some states, community property must go through the probate process. In others, you can add the “right of survivorship” to your community property, which means that when one spouse dies, the other automatically owns the deceased spouse’s half of the community property, avoiding probate.
An advantage of retaining community property status is that, upon the death of the first spouse, the property’s entire cost basis steps up to its current fair market value instead of the cost basis being its initial purchase price. This is different from property held in joint names in common law states, where only the deceased spouse’s one-half interest in jointly titled property steps-up in cost basis. The cost basis of the property can have a significant impact on the capital gains taxes that are due upon sale of the property. Internal Revenue Service Publication 555 is a good resource to learn about federal income tax rules pertaining to community property, and even includes state-specific information.
A surviving spouse’s retirement plan or individual retirement account (IRA) is generally subject to community property laws, but there are limitations. For instance, the surviving spouse’s interest in a plan may be protected by a federal law called the Employee Retirement Income Securities Act (ERISA). If the plan is subject to ERISA, federal law rather than state community property law determines each spouse’s share. The U.S. Supreme Court has ruled that a deceased spouse’s estate can’t distribute his or her community property interest in a surviving spouse’s ERISA plan.
Not all retirement plans are subject to ERISA. For some plans, the law is still somewhat unclear. If you want to distribute your community property interest in your surviving spouse’s plan upon your death, there may be income tax consequences of the transaction that you need to consider. Consider working with a qualified estate planning attorney or tax advisor to discuss your options.
Marital property is treated very differently in common law states than it is in community property states. The laws of your state can have a tremendous impact on how your property is treated in divorce and after you die. Consult your estate planning attorney to ensure you fully understand the laws of your state and how they apply to your situation. If you move to a new state, revisiting that conversation with your attorney is a worthwhile exercise to ensure you’re fully informed of your property rights and know how to protect them.
Taxpayers should seek advice based on their own particular circumstances from an independent tax advisor.
Examples included herein, if any, are hypothetical and for illustrative purposes only.
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