Community Property Trust Planning

In plain English

Community Property Trust Planning

Community property comes with a tax advantage most of the country never hears about. In the 9 community property states, when the first spouse dies, both halves of the couple's property reset to full market value, the step-up in basis. The surviving spouse can sell the next day and owe little or no income tax on decades of gain. In the other 41 states, only the deceased spouse's half resets. Half the gain stays taxable.

Here is what most people do not know: you do not have to live in a community property state to get that treatment. 5 states, Alaska, Florida, Kentucky, South Dakota, and Tennessee, let married couples opt in by setting up a community property trust. Residents and non-residents alike can use them under certain conditions; the usual condition is naming a trustee located in that state, often a bank or trust company. Both spouses sign, the trust declares the property community property, and assets the couple chooses are placed inside.

Understand what this reduces: income tax, not the estate tax. The estate tax touches almost no one now, the exemption is $15 million per person. The income tax on a lifetime of gain touches every surviving spouse who sells. A community property trust is aimed at the tax families actually pay: it can turn a taxable sale after the first death into a tax-free one, because the survivor receives a full step-up in basis on the whole asset, not half of it.

There are trade-offs, and the honest move is to name them before the trust is drafted. Property inside the trust is treated as community property if there is a divorce or a creditor claim, protections that some couples currently enjoy on jointly held property can change. Property that falls in value steps down at death instead of up, so declining assets do not belong inside. And because the IRS has never issued formal guidance on the elective version, careful attorneys treat the full step-up as a strong, well-supported position rather than a stamped guarantee. None of this kills the strategy. It shapes it: put the right assets in, keep the wrong ones out, and draft around the disadvantages so you keep what the law gives. Take the advantage. Plan around the rest.