Community Property

Community property is a system of marital property law under which property acquired by either spouse during the marriage, including each spouse's earnings, is owned equally by both. Property owned before the marriage, and property received during it by gift or inheritance, is generally separate property. IRS Publication 555 names the nine states whose residents it addresses: Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington and Wisconsin. The vocabulary is not uniform across them. Wisconsin's statute calls the same thing marital property and then states the connection expressly, in section 766.001(2): "It is the intent of the legislature that marital property is a form of community property." A Wisconsin couple searching their own statutes will not find the operative term they were told to look for.

The rule that matters most is a basis rule, and Publication 555 states it in plain terms. "If you own community property and your spouse dies, the total fair market value (FMV) of the community property, including the part that belongs to you, generally becomes the basis of the entire property." Section 1014(b)(6) is the statutory authority, and it reaches "property which represents the surviving spouse's one-half share of community property held by the decedent and the surviving spouse under the community property laws of any state, or possession of the United States or any foreign country," so a foreign community regime can qualify too. In a common-law state only the decedent's share gets a new basis. That difference, applied to a long-held appreciated asset, is worth more than most of the estate planning a couple will ever do.

The condition attached to it is real and almost always satisfied, and both halves of that sentence deserve saying. At least half the value of the community interest must be includible in the decedent's gross estate. But Publication 555 adds the qualifier that makes it broadly available: "whether or not the estate must file a return." So a surviving spouse well below any filing threshold still gets the adjustment, and nothing needs to be filed to earn it.

The rule does not apply to registered domestic partners. Publication 555 says so in a parenthesis, immediately after stating the rule: "this rule doesn't apply to RDPs." The consequence is an asymmetry that the parenthesis is easy to read past. A registered domestic partnership in a state that extends community property treatment to it gets the income-splitting consequences, and does not get the basis benefit at the first death. Any planning built on the double basis adjustment has to establish that the couple is married for federal purposes.

It is a basis adjustment, not a step-up, and in a community property state the downside is doubled too. Section 1014 sets basis to fair market value at death, whichever direction that runs. An asset worth less at death than it cost has its basis reduced, wasting the loss, and in a community property state that reduction applies to both halves where a common-law state would reduce only the decedent's. Community property is not strictly better than separate ownership, and a depreciated position is the case where it is worse.

Domicile is the test, and moving creates a durable mess. Publication 555 keys its treatment to being domiciled in a community property state, which is a question of where a person's permanent home is rather than where they happen to live or where an asset is located. Property generally keeps the character it had when it was acquired, so a couple who earned and saved in Illinois and then retired to Nevada can hold separate property and community property side by side in the same brokerage account. Wisconsin makes the timing explicit with a "determination date," defined in section 766.01(5) as the last of the marriage, the date both spouses are domiciled in the state, and January 1, 1986. Nothing on an account statement records any of this, which is why the character of assets after a move is a question worth answering deliberately rather than discovering later.

Three states let couples opt in from outside, and the federal treatment is unresolved. Alaska, Tennessee and South Dakota permit an elective community property trust, which a married couple domiciled anywhere can use to characterize assets as community property. Publication 555 addresses those regimes only to say it does not address them: "This publication doesn't address the federal tax treatment of income or property subject to the 'community property' election under Alaska, Tennessee, and South Dakota state laws." Since the double basis adjustment is the entire commercial rationale for those trusts, and the IRS has declined to confirm that it applies to them, this page does not state that it does. What can be said is what the state law does, which is to characterize the property; what happens federally has not been confirmed by the agency that would confirm it.

Community property with right of survivorship is a different instrument from plain community property. It is a titling form, available in some but not all of the nine states, that adds automatic transfer to the surviving spouse at death and so avoids probate for that asset. Plain community property does not itself avoid probate. Treating the two as the same thing produces the wrong answer about what happens at the first death, which is why how the deed or the account registration actually reads is worth checking rather than assuming.

Three questions decide how community property applies to a given asset. Is the couple domiciled in one of the nine states, and were they when the asset was acquired. Was the asset acquired during the marriage, as opposed to before it or by gift or inheritance during it. And has the couple's own agreement changed the default, since a valid marital agreement can characterize property differently from the statutory default.

The worked example below is the one in Publication 555, so a reader can check it against the source. Taylor and Blake owned community property with a basis of $80,000. When Taylor died, the property had a fair market value of $100,000, and one-half of that value was includible in Taylor's estate. The basis of Blake's half becomes $50,000, being half of the $100,000 value, and the basis of the other half to Taylor's heirs is also $50,000. The entire property now carries a $100,000 basis.

Run the same facts in a common-law state to see the difference. Each spouse's half started at $40,000 of basis. The decedent's half is adjusted to $50,000 and the survivor's half stays at $40,000, so the property carries $90,000 of basis rather than $100,000. On a position with larger appreciation the gap widens in proportion, and the survivor pays capital gains tax on the difference whenever they sell.

Debts are community too, which is the half readers do not anticipate. Obligations one spouse incurs during the marriage can generally reach community assets, not only that spouse's separate property. Wisconsin devotes a statute section to it, section 766.55, titled "Obligations of spouses." The details vary materially between the nine states, so the general point is worth knowing and no specific creditor rule should be assumed to be national.

Federal law switches community property off in named places, and two of them matter. Section 32(c)(2)(B)(i) provides that for the earned income tax credit "the earned income of an individual shall be computed without regard to any community property laws," so a spouse counts only their own earnings there. More consequentially, survivor rights in a workplace retirement plan are federal. Whether a spouse must consent to a beneficiary designation on a 401(k), and what they are entitled to if they do not, is governed by federal plan law rather than by state marital property law. An individual retirement account is different again, because it sits outside that federal regime, which is where a state-law community property claim can genuinely matter. So a flat statement that "in a community property state your spouse owns half of your retirement accounts" reaches the right answer for the wrong reason in one case and the wrong answer in the other.

Pros

• Both halves of community property receive a new basis at the first death, which can eliminate a lifetime of unrealized gain for the surviving spouse.
• The basis adjustment does not depend on filing an estate tax return, so it reaches couples of ordinary means.
• Ownership is clear by operation of law rather than depending on whose name is on an account, which protects a spouse who earned less or nothing.
• Equal ownership is automatic, requiring no document and no action by the couple.

Cons

• The basis adjustment runs downward as well as upward, and in a community property state a loss is wasted on both halves rather than one.
• Debts incurred by one spouse during the marriage can reach community assets.
• Moving between states leaves a mixture of community and separate property that is invisible on account statements and hard to reconstruct later.
• Terminology and detail differ across the nine states, so guidance written for one is unreliable for another.
• Registered domestic partners are excluded from the basis rule even where state law extends community property to them.
• The federal treatment of an elective community property trust in one of the three opt-in states has not been confirmed by the IRS.