Diedre just responded a moment ago to a question on www.avvo.com, the lawyer-rating service. The querent wanted to know if property in a joint revocable living trust is community property for purposes of receiving a full step-up in capital gains tax basis upon the death of the first spouse.
Diedre’s answer provided several alternatives to ensure that property receives the desired characterization — whether community or separate — with a reminder that what’s effective for tax law will also be enforced by a divorce court.
A quick primer on capital gains law for readers new to this area of taxation:
If a married person owns separate property with built-in capital gains (meaning the market value of the property is higher than what the person paid for the property), that gain (the difference between the purchase price and the sales price) would be subject to capital-gains tax upon the sale or disposition of the property. When the married property owner dies, all of that built-in capital-gain disappears for tax purposes. In other words, while the now-deceased owner would have paid tax had he or she sold during life, the inheritor-spouse will only be subject to capital-gains tax on any gains that occur AFTER the initial spouse’s death. But if it is the non-owning spouse who dies first, the owning spouse receives NO capital-gains tax relief.
Capital gain in community property that would be subject to tax during both spouses’ lifetimes disappear when EITHER spouse dies. This is even better than the treatment a surviving spouse would get if the IRS characterized the property as half the husband’s and half the wife’s. In that case, only the decedent’s half gets a step-up to fair market value when one spouse dies.
In other words, community property, which is available in nine states (and possibly to residents of the other 41 states through the use of an Alaska Community Property Trust), provides a tax benefit that can be worth a substantial sum — especially if the assets have been held for a long time, seeing years of gains.
For additional information on these topics, check out:
- Do You Always Have to Pay Capital Gains Taxes After Selling Your Home? (brighthub.com)
- Capital Gains and Losses (turbotax.intuit.com)
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