Unknown to many Floridians, Florida enacted the Community Property Trust Act which went into effect on July 1, 2021, and established the ability to convert non-community property into community property. The community property “opt-in” option is a welcome addition to the Florida statutes, which, when analyzed carefully, may provide income tax benefits, particularly for homeowners with highly appreciated real estate.
What is Community Property?
The United States recognizes two types of property law for married couples: separate property (also known as the common law system) and community property. Nevada, New Mexico, Texas, Washington, Arizona, California, Idaho, Louisiana and Wisconsin have adopted the community property regime. The other 41 states (Florida among them) follow the separate property system based on common law.
Florida (together with Alaska, South Dakota, Tennessee and Kentucky), permit couples to “opt in” to a community property regime via the use of a “community property trust” (“CPT”) which may provide some opportunistic tax benefits as will be discussed below.
In separate property states, property acquired during marriage is generally deemed to be the separate property of the spouse who acquired it (special rules usually apply, however, to property divisions on divorce).
The community property system, on the other hand, follows the theory that property acquired by spouses during marriage should be construed as one total “community” of property. Property acquired during marriage is considered owned one-half by each spouse regardless of how title to the property is taken. On divorce or death, there is a partition of the community property and each spouse (or the predeceasing spouse’s estate in the event of death) is vested with his or her one-half interest.
The separate or community property classification of a particular asset is determined at the time the asset is acquired in accordance with the laws of the state in which the couple was domiciled when acquired. An asset’s original classification is generally thought to not be altered when the couple later moves to a different state — that is, the character of property generally follows the couple as they move from state to state (except in the case of quasi-community property, which is recognized in community property states as separate property that would have been community property if acquired in that state in order to protect a non-owner spouse upon a property division).
Florida’s Community Property Trust Act (CPTA) allows for the community property “opt-in” ability through the creation of a trust, referred to as a “Community Property Trust” (“CPT”). The advantage of using a CPT may result in the property held in such trust receiving a full step-up in income tax basis upon the death of the first spouse rather than a 50% step-up in income tax basis for most property owned jointly by Florida resident spouses. This is because the IRS typically defers to the status and title of ownership at the state level when applying federal Internal Revenue Code. The application in the case of the titling of an asset as community property may result in a favorable income tax result.
The benefit of receiving a full step-up in income tax basis to fair market value at the date of the first spouse’s death is that the surviving spouse can then sell such asset without incurring capital gains tax on the entire appreciation that occurred prior to the deceased spouse’s death (as compared to only one-half of such appreciation that occurred prior to the deceased spouse’s death under the tax law where a property is owned jointly between spouses).
Caveats to Using CPTs
Firstly, this has not been tested by the IRS to date. While the IRS has respected community property when established in a state such as California where there is no other option but to title the property as community property, “opting in” to community property, on the other hand, has not been tested and may be challenged by the IRS. With that said, even if the IRS does indeed contest the integrity of the community property status, one would not be in a worse tax position than if he left the property as joint tenant with rights of survivorship or tenants by entirety.
Another caveat to keep in mind is the Florida document stamp may be applicable upon the transfer of the real estate to the CPT. While Florida has a carveout, such as Florida Administrative Statute 12.4.013(32)(c), which states that a deed from an individual to the trustee of a trust is exempt from doc stamps if there are persons other than the grantor that are beneficiaries of the trust, it is still important to double check with a real estate professional prior to making the transfer.
Lastly, while the CPT may have tax advantages, there may be adverse consequences if there is a prenuptial agreement in place prior to the conversion of the community property. One should consult with their family law attorney to discuss how converting the residence to community property will affect their prenuptial agreement.
In conclusion, the Florida Community Property Act may be able to help with maximizing the step-up benefits upon each spouse’s passing and will consequently reduce the beneficiary’s capital gain exposure upon the subsequent sale of the residence. Before taking any action, seeking the advice of local tax counsel is a worthy step to best understand your personal circumstances.
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