March 24, 2022

Dear Clients and Friends:

Florida has recently enacted legislation in an attempt to gain the tax advantages of “community property,” which is a form of ownership between spouses common in states from Texas and further West.  The tax advantage relates to securing a 100% cost basis increase in assets owned by spouses upon the death of the first, which eliminates any inherent capital gain.  For example, if a married couple owns $10 million dollars of community property, with a cost basis of $2 million, they are deemed to own those assets 50%-50%, much like joint property.  However, unlike community property on the death of one of those spouses, joint property would receive only a 50% basis increase. In this example, the surviving spouse would receive a basis increase of $4 million (50% of the $8 million spread between cost and value).  If the property were community property, pursuant to a unique Internal Revenue Code (“IRC”) statute, the increase would be the entire $8 million, or a potential difference of over $1 million in potential capital gains tax savings if the property were sold. If the surviving spouse owned those assets on her subsequent death and they became worth $15 million, a second 100% basis increase would occur, potentially without estate tax exposure.

IRC § 1014(b)(6) provides for the result in the above example, by deeming the one-half interest owned by the surviving spouse to pass with the decedent’s half (combined as one) to the surviving spouse. This occurs whether or not the decedent’s half actually passes to the surviving spouse. As such, securing community property status does not negate estate tax planning, because the decedent may still pass the decedent’s 50% to estate tax exempt trusts for the benefit of the surviving spouse.

Florida Statutes §§ 736.1501-1512 provide the Florida law associated with establishing community property in Florida.  In order to distinguish community property from joint property between spouses, various rules apply.  A trust must be used, and each spouse is considered to independently own and control their 50%, which they can dispose of separately or as they agree at death.  As a result, a couple with a taxable estate can implement traditional base estate planning, using their respective estate and generation skipping tax exemptions. Doing so may sometimes result in forfeiting the second basis step-up on the surviving spouse’s estate, in order to preserve the estate, gift, and generation skipping tax exemptions of the first spouse to die. Clients who have used their estate and gift tax exemptions in tax reform planning may benefit from securing community property status, by swapping assets with large gains out of irrevocable trusts that were created to utilize exemptions.

Use of a community property trust may not be appropriate in second marriages or where one spouse has significant liabilities or liability exposures. Various considerations are involved in this type of planning, as not only tax law is involved.  The property rights and objectives of each spouse must be considered.

Please let us know if you have any questions. We are pleased to be of service.

Joe Kempe

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