In many aspects, state law recognizes married couples as a single economic unit. By default, married couples have certain rights to property that they hold and accumulate over their lifetimes together.
The percent ownership each married individual has in a given asset depends on the asset ownership structure and the state in which the couple lives or the asset is located.
- Most states are common law states. In common law states, which spouse owns a particular asset is determined based on who holds title to the asset. However, upon death of the first spouse, the surviving spouse may have an elective share to assets titled in the other’s name
- 11 states are community property states. Income earned or assets purchased by the married couple during marriage are by default presumed to be owned 50-50 by each spouse, regardless of title, and both spouses generally have an equal right to manage the community property
How does community property work?
Imagine putting together a two-colored puzzle.
Before marriage, each spouse individually owns certain assets representing that spouse's own color. This is their separate property.
During marriage, any new income earned or assets acquired is by default owned 50-50 between the spouses as community property. The spouses still individually own and control 100% of their separate property.
After marriage, whether by death or divorce, each spouse owns that spouse's separate property and 50% of the community property.
How does property become community property?
The characterization of a particular asset as community or separate property can be determined in one of two ways:
- Default presumptions under the law
- Declarations of spouses or registered domestic partners that override the default assumptions
In community property states, income earned or assets purchased by an individual in a marriage or registered domestic partnership are community property assets by default. This means that each spouse or partner has a 50% share in that income or asset.
Married individuals can mutually agree to override that default 50% share assumption through legal documentation that specifically designates the income or asset as separate property belonging only to one person. There are two common ways to do this:
- Waiving community property rights on death or divorce by either a premarital (prenuptial) agreement or a marital property (postnuptial) agreement
- Changing the character of the marital property through a transmutation agreement, a fancy-sounding name that simply means the agreement can change the property's character from community property to separate property and vice versa
Exceptions to Community Property
Most property acquired during a marriage in community property states is presumed to be community property, with a few exceptions:
- Property acquired by gift or inheritance
- Property acquired by personal injury damages (in certain circumstances)
- Income or rents earned by the separate property of either spouse
- Property acquired after the separation of spouses, if part of a legal separation or divorce proceeding
If the married couple desires to continue to hold these assets as separate property, the property records and accounting should be kept separate from all other community property. If separate property and community property are commingled together and the separate property cannot be traced to its origin, the property is presumed to be community property.
Advantages to Holding Property as Community Property
Community property can provide married individuals with certain income tax benefits that are not available to separate property.
Under current law, when a spouse dies owning separate property, that separate property receives an adjustment in basis for income tax purposes up to the fair market value at the date of death, known as a step-up or step-down in basis. Separate property held by the surviving spouse retains its basis and is not affected by the first spouse’s death.
When a spouse dies owning community property, both the deceased spouse’s ½ share and the surviving spouse’s ½ share in the community property are stepped up or down to the current fair market value. For a community property asset that has gained considerably in value, this means that the surviving spouse could sell the community property asset shortly after the death of the first spouse paying little or no federal or state capital gains tax.
For examples of what this tax savings might mean in practice, check out our separate article on the tax benefits of community property.
Drawbacks to Holding Property as Community Property
Holding property as community property offers weaker asset protection compared to separate property.
During marriage, community property is subject to all creditor claims of the community (i.e., both spouses acting jointly) as well as the creditors of either spouse. The creditors of a deceased spouse also can make a claim in community property up to the deceased spouse’s ½ share interest in the community property.
With some exceptions, this liability for debts holds regardless of whether the other spouse has management and control over the property and whether one or both spouses are parties subject to the debt.
What Happens to Community Property at Death?
Upon the death of a married individual holding community property, interest in the community property is split into two shares:
- One half of the community property belongs to the surviving spouse
- One half of the community property belongs to the deceased spouse. This one half share passes to a new owner in one of the following ways:
- By title or beneficiary designation for assets held with a survivorship right or beneficiary designation
- Through the deceased spouse’s estate plan, whether that be a last will or revocable trust
- By default to the surviving spouse, if the deceased spouse does not have an estate plan and the assets do not otherwise pass by title or beneficiary designation
Estate Planning with Community Property
Many couples who hold community property or live in community property states like California choose to create a joint revocable trust.
In comparison to separate revocable trusts for married individuals, a joint revocable trust is typically easier to manage during the lifetime of the couple because all the assets are owned by one trust. There is no duplication of paperwork in creating, funding, and modifying or revoking a joint trust like there is with separate trusts. The couple also benefits from not needing to keep multiple records, split real estate taxes and other bills, and recalibrate assets between two separate trusts.
Couples can plan distributions upon death of the first spouse in a joint revocable trust that mirror one another or differ depending on which spouse passes away first.
