Community Property

April 13, 2006

	Visited: 141
	Not rated
	Rate:

When considering forms of home ownership if no homestead exemption is available, from an asset exemption standpoint, the results are the worst when property is owned as community property. In that case, the creditors of one spouse can reach the entire value of the property, not just that spouse's portion.

Community property law exists in only a relatively small group of states:

Community Property States
Arizona	Louisiana	Texas
California	Nevada	Washington
Idaho	New Mexico	Wisconsin

In these states, property acquired by a married couple during marriage, other than through individual gift or inheritance, is presumed to be owned in community property, regardless of which spouse's name is on the title or other ownership document. What's more, property that was acquired before the marriage, or during the marriage by gift or inheritance, may be transformed into community property if it is mixed or "co-mingled" with other community property.

Also, if you have ever lived in a community property state and later move out of it, your existing community property retains its character despite your change in residence.

Work Smart

Married couples who own property, such as a home or investments, in a community property state may want to consider converting the ownership to joint tenancy, at least where only one spouse will be incurring the majority of debts. This will shield half of the value of the property.

Alternatively, the entire interest might be conveyed to the other (non-business-owner) spouse. This can be quite effective, but also quite risky due to the possibility of divorce.

It is also possible to remove the property from community property status so that each spouse owns one-half of the asset as his or her separate property, or jointly own the property in the tenants in common form of ownership.

If you live in a community property state, in order to opt out of the community property law with respect to some or all of your property, both spouses must sign what is known as a "transmutation agreement." This document, which must be carefully drafted by an attorney, can transform your property ownership into whichever form you wish, and can be written to apply to your existing property as well as property you acquire in the future.

Any change in ownership here must be carefully considered. The community property ownership form was designed to accord equal property rights to spouses. Thus, planning here may involve giving up some of these rights, and the cost of doing this must be weighed against the benefits derived.

You should be aware that community property can impart an income tax advantage, despite its extreme disadvantage from an asset protection perspective: When one spouse dies, and the other inherits the other half of the property, the survivor receives a "stepped up" basis for the whole interest in the property rather than just the half he or she received. This means that any appreciation in the value of the property--between the time the couple had purchased the asset and the date of the first spouse's death--will not be taxed when the property is later sold.

By contrast, in joint tenancy, upon the death of one spouse, the other gets a stepped-up basis for only that spouse's half-interest. (Nevertheless, with the first $250,000 of capital gain per person from the sale of a home now automatically tax-free, for most taxpayers there may be no real advantage here with respect to a home.) The advantage may still exist for investments and other assets that appreciate in value. Still, the risks in this ownership form may outweigh any income tax benefits.