This article applies to Florida and Tennessee law, but note that ANYONE in ANY STATE can create and fund (put assets into) a Tennessee or Florida Community Property Trust (including real property, brokerage accounts, etc.), even when that property is located in another state and even when the person is not a resident of either state. Some restrictions apply, but they are fairly easy to accommodate for most people. Read on to learn more about Community Property Trusts and how they might be a valuable part of your comprehensive estate plan.
Florida & Tennessee Have Some Excellent Estate Planning Tools
Tennessee is known for having one of the most, if not THE most, favorable set of laws regarding trusts. Florida is working hard to catch up, itself having passed some new laws in 2021 that benefit trust makers. The Community Property Trust in these two states is surprisingly similar.
What Trusts Do
Trusts, for the most part, are designed to do a few very important things as part of a comprehensive estate plan. They can help you (among other things). . .
- Save money on capital gains taxes, estate taxes, income taxes, and in some cases, franchise and excise taxes
- Keep assets protected from creditors (of self, of a business, or of others)
- Provide for children of other marriages
- Provide for your own or a spouse’s care in the event of a disability, temporary or permanent
- Ensure the inheritance of assets is secured to those you designate, long after your death
- Keep your financial affairs private
- Ensure a loved one with special needs will have the assets, care, and guardianship needed when you’re gone or unable to care for them
- Ensure for the guardianship and care of minor children in the event of your disability or death
- Put controls in place for an heir who has a history of getting into financial difficulties due to their spending or bad habits
- Allow for legacy wealth to be available to generations of descendants, shielded from creditors and many taxes
There are many other things trusts can do, but the focus of this article is on the Tennessee and Florida Community Property Trusts, sometimes also called Community Property Living Trusts. It’s a very special type of trust that was designed to give anyone (not just residents of Tennessee or Florida) the benefits enjoyed by people who live in Community Property states.
Why Do I Want My Assets Treated as Community Property?
Tax savings is the biggest reason, specifically capital gains tax. To appreciate how this works, you need to understand the concept of tax “basis” and how capital gains taxes are calculated.
Calculating Tax Basis
When you purchase an asset, say for example a house or shares of stock in a company, you pay a certain price on the day you buy it; this is your “tax basis” for that asset or “basis” for short. For illustrative purposes, we’ll say you and your spouse bought a house in 2019 for $500,000 and 100 shares of stock in Apple at $250 per share (i.e., an investment and “basis” of $25,000.) In 2022, you put both of those assets into a Tennessee or Florida Community Property Trust by simply titling them in the name of the trust that’s been created for you by your attorney.
Then, sadly, in 2030, you pass away, leaving your spouse widowed. The house is worth $1,800,000 and the stock is worth $250,000. You have these assets with your spouse as trustee in your community property trust (thank goodness), so she/he receives them with a new, full “step-up” in basis. This means that whatever the fair market value of your house and stock portfolio was on the day you died, that will be her/his new basis from which capital gains taxes would be calculated if she sold the assets. In other words, she could sell the home and the stock right after your death and pay zero taxes on all of that appreciation.
What Happens to the Basis of my Assets Not Held In a Community Property Trust?
What would happen if you didn’t have those assets in the Community Property Trust? The new step-up basis would only be 1/2 the amount you’d get in the Community Property Trust. The calculation is original purchase price + fair market value on date of death x 50%. That’s the amount that is considered capital gains and subject to taxation.
That would make the new tax basis for the home [500,000 + 1,800,000 x 50% = 1,150,000] instead of the basis of 0 that you’d receive inside a Community Property Trust. It makes the new basis for the stock [25,000+250,000 x 50% = 137,500].
To determine the approximate capital gains tax on the home sale, we take the sales price of $1,800,000 and subtract the basis of $1,150,000 to get $650,000 (that’s your gain.) Only $500,000 of this passes free of capital gains tax (a couple gets to keep $500,000 of gains tax free on the sale of a residence), so that means $150,000 will be taxed at whatever the surviving spouse’s income tax rate is at the time. If it’s 20%, the tax will be $30,000.
On the stock portfolio, we take the sale price of $250,000, subtract the basis of $137,500 and have the taxable gain of $112,500. With a tax rate of 20%, that’s a tax bill of $22,500.
So, in total, without a Community Property Trust holding those assets, the tax bill would be $52,500.
That is a LOT of money to send off to Uncle Sam when you could keep it for yourself and your family. Note that if you were to both pass away prior to selling the property and the stock, your heirs would inherit those assets with a fully stepped up basis, so again, if they sold at fair market value as calculated on the date of the last to die, they would owe no taxes.
The Risks of a Community Property Trust
Community Property Trusts are not for everyone. There could be some risks associated with using them as part of an estate plan. For example, a couple with this type of trust who then gets divorced will find that the assets will be split 50/50, as if they were getting divorced in a community property state. In Tennessee and Florida, equitable distributions rules might allow for an un-even split to make things “fair”. Couples considering a Community Property Trust should be aware of this feature.
Additionally, because this is a new-ish type of estate planning tool, we do not have a lot of direct guidance from the IRS about how it might choose to tax the assets in the trust. There is a significant amount of evidence that suggests they would view it as we’ve described here, but until we get an official IRS ruling on it, we won’t know for sure. The good news is that if the IRS decides to go against its past actions and not agree with the interpretation of the code, clients will be no worse off than they would have been putting their assets into a more standard Revocable Living Trust.
The last risk is loss of creditor protections available to assets titled as “Tenants by the Entirety”. Married couples can title their home or stock portfolios as Tenants by the Entirety, and this protects the asset from being taken by creditors of one spouse when the other spouse is not in debt to that creditor. This may be alleviated by certain clauses in the Community Property Trust that we draft at our firm, but until it is litigated in court, we cannot know for sure. If you are concerned about creditors attaching your assets because of your spouse’s debt problems, titling them in a form that is not Tenants by the Entirety might not be a good idea. You’ll need to speak to your attorney in order to make the best decision.
Restrictions
I mentioned in the opening paragraph of this article that there are some restrictions to having a Tennessee or Florida Community Property Trust, but that they’re easy to accommodate. First, you must be married. Community Property Trusts are only valid between spouses. And second, the trustee of the trust must either be a resident of the state hosting the trust (Florida for a Florida Community Property Trust, Tennessee for a Tennessee Community Property Trust) or a corporate entity in that state, which can be accomplished by using a corporate trustee (many banks fulfill this function), if you personally are not a resident of one of those states.
If you’d like to find out if your particular situation warrants a closer look at a Community Property Trust for your own estate plan, please fill out our firm’s INTAKE FORM and we’ll get back to you within 24 hours for a quick, free consultation.