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Dear Mr. Premack: Last week you gave us an overview of
several new laws. One of them was about changing separate property into
community property. A few years ago I inherited a rent house, which is my
separate property. Why would I want to make it into community property? Is
there an upside, and is there a downside to making the change? – A.D. via
Email
Texas law has, for more than 100 years, distinguished between community
and separate property. Separate property includes anything 1) owned before
your marriage, 2) received by gift or inheritance during your marriage, or
3) you and your spouse agree (in writing) is separate property.
Now, if approved by the voters in the November 2 election, spouses will
be able to take exactly the opposite approach by changing separate
property into community. The new law will be effective on January 1, 2000
as part of the Texas Family Code if approved by the voters.. But, as you
ask, why would someone make this change?
There are a few reasons that you may NOT want to make the change. For
instance, separate property is under your sole management and control. If
your spouse has debts, your separate property is probably unreachable by
those creditors. If you are divorced, your spouse should have no claim to
your separate property. If you die, you can easily pass your separate
property to your children instead of to your spouse.
On the other hand, the desire to convert assets into community property
is largely tax motivated. Because community property is owned 50-50 by
each spouse, the taxable estate of each spouse is equal. As a result, it
is easier to legally reduce or eliminate federal estate taxes.
For instance, if one spouse owns separate property worth $1 million,
and the other spouse’s assets are worth $100,000, there may be a higher
estate tax if the wealthier spouse dies second. This is because the less
affluent spouse cannot fully utilize the federal unified credit (which
currently eliminates estate tax on up to $650,000).
To save taxes, the spouses can balance their ownership interests. The
wealthier spouse, in the above example, could give $450,000 to the less
affluent spouse (without worrying about gift tax.) They would then each
own estates valued at $550,000 and could legally eliminate estate taxes
when they die. However, under the old law, since the assets started out as
separate property, they remained separate property (even though they may
have been owned jointly by both spouses).
The basis of separate property is not treated as favorably as is
community property when a spouse dies. When separate property is
inherited, only the separate property is assigned a stepped-up basis. In
the example, only the $550,000 owned by the first to die is given a new
basis. The basis of the other half stays at whatever level it already had,
so when it is sold the capital gain taxes may be significant.
On the other hand, all community property is given a fully stepped-up
basis when one spouse dies. As a result, then entire $1.1 million would be
assigned a new basis. If the survivor elects to sell any investments,
there could be a substantial reduction or elimination of capital gain
taxes. These "upsides" and "downsides" will affect different couples in
different ways. You should consult with your attorney to see what the
effects would be for you. |
