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 Community Property and Joint TenancyWhat is "community property"? There are nine community property states. They are Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin (which has a sort of modified community property law). Community property is generally defined as all property acquired during marriage, and such property is considered to be owned equally by both spouses no matter whose name is on the title. Examples of community property would be the salary earned by a husband or wife, a house purchased by a married couple with community funds, and a gift or inheritance given to both spouses rather than to an individual spouse. A spouse may also have his or her separate property which is considered to be that spouse's sole property, separate from community property. Separate property includes: All property acquired prior to marriage All property acquired, even during marriage, by gift or inheritance by an individual spouse, rents and profits derived from separate property. Examples of separate property are the car you owned prior to marriage, a beach house you received under your grandmother's will, or $10,000 given to you by your rich uncle. If you rent property at the beach house to a tenant, that rent would be separate property. If you invest the $10,000 in a savings account, the interest would be separate property. What is a "community property agreement"? A community property agreement is a very commonly used estate planning tool for those people who live in a community property state or who have acquired property in a community property state. A community property agreement is a special contract between husband and wife in which they specifically agree as to the ownership and disposition of their community and separate property. The general requirements of a community property agreement are that it be made between a husband and wife, that it be in writing and signed by the husband and wife, that it set out the rights of the spouses to the property, and that it be acknowledged in the same manner as a deed. It is important to be aware that all community property agreements are not the same. Some community property agreements convert any and all separate property into the community property of the spouses. Other community property agreements permit the ownership of separate property during the lifetimes of the spouses, but provide that upon the death of the first spouse, all the separate property of that spouse is converted to community property and automatically passes to the surviving spouse. A community property agreement can also be drafted to pass community property automatically to the surviving spouse on death but have no effect upon the separate property, which would then pass either by will, trust, or intestate succession. There are a number of advantages to the use of community property agreements. First, there is simplicity of identification of all property as community property, thereby eliminating complicated tracing of separate and community property. Second, upon the death of the first spouse, probate can be eliminated if the property passes to the surviving spouse. The surviving spouse merely records an affidavit together with the original community property agreement and a certified copy of the death certificate with the county records. These documents will serve as the link in the chain of title for real property owned by the couple. The real estate records will then show that the surviving spouse is the sole owner of the real property. Other titled property such as vehicles may be transferred by giving licensing authorities copies of the community property agreement and the death certificate. The surviving spouse will file the final joint income tax return and a federal estate tax return, if required. Another advantage of a community agreement is that it allows a spouse to maintain ownership of separate property during his or her life in order to preserve the ability to make gifts without the consent of the other spouse. Also, sometimes a community property agreement is used by spouses to protect their separate property from the claims of the other spouse in the event of a divorce. There are also disadvantages to community property agreements as well. A community property agreement is a contract between the spouses. Unlike a will or a trust, revoking or changing the community property agreement requires the agreement of both spouses. The agreement is not revoked by a pending divorce, an inconsistent will, or any other unilateral action. Therefore, if a spouse in later years becomes concerned that the surviving spouse might remarry and leave the community property to that new spouse, he or she cannot establish a different estate plan requiring ultimate disposition to his or her children without the other spouse's consent. For this reason, community property agreements are often inappropriate for second marriages because there is no protection for the children of the first marriage. A community property agreement does not eliminate the necessity of a will or a trust, because there is no provision for simultaneous death, for secondary beneficiaries, for specific bequests, or for naming guardians and trustees for minor children. Specific gifts of separate property or a portion of the community property cannot be made under a community property agreement. All property passes to the surviving spouse. Because a community property agreement may be unique to a particular state, it probably will not be effective for transferring real property located in another state. The property will pass according to the law of that state. Another major disadvantage of a community property agreement is that it can defeat tax planning for larger estates. In the event that an estate is large enough for tax savings to be achieved through a Family or Credit Shelter Trust, the community property agreement may not be appropriate. A community property agreement does not bar creditors' claims. Therefore, professionals who may be subject to malpractice claims often prefer to use alternative means to cut off the claims of creditors, including Living Trusts or the probate process. In spite of its limitations, the community property agreement is an ideal estate planning tool for many married couples and, together with carefully drafted wills or trusts, can be a major part of an estate plan. Are any income tax advantages afforded to community property? Yes, there is a significant income tax benefit afforded to community property. On the death of the first spouse, the entire community property asset, rather than just the deceased spouse's half, is entitled to a step-up in income tax basis. Property transferred to a properly drafted Revocable Living Trust and property subject to a community property agreement continue to be eligible for the full step-up in basis. How are estate taxes calculated for community property? Only one-half of the value of each community property asset is included in the taxable estate of each spouse. This includes cash values and proceeds of life insurance, IRAs, pension benefits, and all other community property. If the entire estate is community property, the estate is automatically equalized for estate tax purposes. How can I determine what is community property and what is separate property? Frequently, because property is sold and reinvested, held over a long period of years, or acquired under uncertain circumstances, it is difficult to determine whether property is community or separate. However, the law favors community property, and if there is any doubt as to classification, any property held by a married person will be presumed to be community property. Separate property can be sold and the proceeds invested in another asset. That asset will also be separate property provided that the source of funds can be "traced" by clear and convincing evidence. Therefore, a spouse can sell his separate house at the beach and reinvest the proceeds in mutual funds held in his separate name, and the mutual funds will be separate property. However, if in the process, the separate property is mixed or "commingled" with community funds such that the separate property cannot be clearly identified, it will lose its classification as separate property. For example, if the proceeds of the beach house are deposited in the community checking account into which paychecks are deposited and out of which community bills are paid, the proceeds will no longer be separate property because they cannot be identified by clear and convincing evidence. It is important to note that the name or names on the title to property do not determine its community or separate status. If property is acquired during marriage with community property or commingled funds, it will be community property even if held in the name of one spouse alone. Classification of property as separate or community is fundamental to estate planning. A spouse is free to sell, give away, or leave, by will or trust, all of his or her separate property in any way he or she wishes. However, during lifetime a spouse cannot give away any single item of community property or even his or her half without the consent of the other spouse. By will, a spouse may control the disposition only as to his or her half interest in any community property asset or half the value of the community property estate. What happens to my community property if I move to a non-community property state? Many states that do not recognize community property ownership have adopted the Uniform Disposition of Community Property Rights at Death Act, which is designed to protect marital rights in property which has been imported from a community property state or acquired by spouses when domiciled in a community property state. By meeting the requirements of this law, it is possible to preserve the benefits of community property even while living in a non-community property state. You should consult with an estate planning lawyer in your new state if you have moved from a community property state to a non-community property state. Can I avoid probate by using joint tenancy with right of survivorship? Many people have become aware of the problems associated with probate and assume they can totally avoid probate by retitling all their assets to read "joint tenancy with right of survivorship" (JTWROS). This can create many unintended and negative consequences. JTWROS is a form of ownership in which two or more people own 100 percent of the same asset. The right of survivorship feature of joint tenancy means that the last joint tenant to die owns the entire asset. Ownership of the asset passes to the surviving joint tenant by operation of law. The other joint tenants merely had the use of the asset during their lifetime. For instance, if Bill and Mary--husband and wife--own their house as joint tenants with right of survivorship and Bill dies, the title to the house passes to Mary by operation of law and does not have to pass through probate. However, upon Mary's death, the house will have to pass through probate before her children can take control of the house. Although JTWROS can postpone probate, it doesn't completely avoid it. After Bill's death, Mary could add her oldest son to the title of her house to avoid probate upon her death. However, in doing so, she could inadvertently encounter some gift tax problems, expose her assets to her son's creditors, lose control over her property, and create unnecessary income and gift tax problems for her beneficiaries after her death. Additionally, if Bill or Mary, or any other joint tenant, became mentally incapacitated, the jointly held house could be "frozen" by law. The other joint tenants would be prohibited from selling the house until the probate court stepped in and permitted the sale. Owning assets in JTWROS creates taxes without the benefit of ownership. For example, if Tim and Pete, brothers, own a cottage on a northern Michigan lake as joint tenants with right of survivorship and Tim dies, title to the cottage passes immediately to Pete without going through probate. However, even though Tim's family will receive no benefit of the cottage, one-half of the value of the cottage is included in Tim's estate for federal estate tax purposes. Does joint tenancy avoid a Living Probate? No. Since there are usually two names on the title to joint tenancy property, you would think that the one joint tenant should be able to conduct "business as usual" if the other joint tenant is mentally incompetent. However, this is not the case. Joint accounts can be absolutely frozen--by law--if one of the owners is declared legally incapacitated. Joint account agreements can require that the account must be frozen if one joint tenant becomes incapacitated. As to other property, many transactions, by law or custom, require the signature of all joint tenants. If one of them is unable to sign because of incompetency, the probate court may have to be involved. It is usually better to take property out of joint tenancy with right of survivorship and transfer it into a Revocable Living Trust, which can then control the property without court intervention if the owner becomes incompetent. A durable power of attorney can be effective, but it is not uncommon for a third party to insist on a court order rather than relying on a durable power of attorney. Does joint tenancy with right of survivorship avoid a Death Probate? Yes and no. For example, if you and your spouse own your property in joint tenancy, it will avoid probate when the first one of you dies. Without other planning, the property will not avoid probate when the second one of you dies. Probate is not avoided if both of you die simultaneously; there would be two separate probates if that occurs. The fact that joint tenancy avoids probate on the first spouse's death is small consolation for the many problems created by its use. Joint tenancy may be the worst possible probate-avoidance method. It leads to loss of control. It creates the real possibility of unintended heirs. It creates gift taxes for nonspouses. It is great for creditors, and it creates death tax problems. |
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| ©2010, Dallas W. Jolley, Attorney & Counselor at Law. Send questions or comments to info@jolleylaw.com. | |||||
