When the Florida legislature convenes in March, 2021, it is expected to consider legislation authorizing the creation of Florida Community Property Trusts (“FCPTs”). If passed, it would allow Florida residents to “opt-in” to community property treatment. What might this mean to you?
What is community property? There are two property regimes in the United States governing the ownership of property by spouses. Forty-one states (including Florida) apply the common law known as separate property. Nine states (mostly in the west and southwest) have community property systems.
Under the common law approach, property rights generally are controlled by the title to the property. If a wife owns 100 shares of Amazon stock, she can sell them, give them away, or do anything else with them she chooses.
The default in community property jurisdictions is that each spouse owns a 50% interest in the property titled in the name of either spouse. Title doesn’t control property rights between spouses. There are exceptions. For example, in most community property states, the spouses can elect to have an asset treated as the separate property of one of them.
Estate planning has evolved in recent years. For many families, estate planning has changed so that planning for income taxes, specifically capital gains taxes, has become as or more important than planning for estate taxes. This is a result of the Federal estate tax exemption being the highest in history – $11,580,000 for each spouse in 2020 ($23,160,000 for a married couple). That eliminates estate tax concerns for more than 99.5% of Americans.
On the other hand, stocks, real estate, and other investments have appreciated substantially since the end of the great recession in early 2009. From the market low on March 6, 2009, through August 2020, the S&P 500 has returned 350%, and Amazon has returned more than 5,000%! Many families are reluctant to sell highly appreciated assets and incur a capital gains tax.
Often, the solution is to hold the appreciated assets until death in order to obtain a basis “step-up,” thereby eliminating the tax cost associated with them. But how should the assets be titled? If Florida residents own the property in the name of one spouse or the other, they have to guess which spouse will die first. If property is titled in joint names, only one-half of the interest will have its basis stepped-up when the first spouse dies.
Community property rules are different. The Internal Revenue Code provides that the full value of community property will have it basis step-up at the death of the first spouse, and then again at the death of the second spouse. The tax law thus treats residents of the nine community property states more favorably than those living in separate property states.
How to take advantage of the community property basis rules despite living in a separate property state? If enacted, the proposed legislation may give Florida residents the option to convert some or all of their separate property to community property by contributing the assets to a FCPT. The requirements to create a FCPT are straightforward and easy to accomplish.
The assets will be treated as community property as long as they are held in the FCPT. They will again be separate property when distributed from the trust. If the parties divorce, the FCPT assets will be distributed one-half to each spouse. If assets remain in the trust when one spouse dies, one-half of the FCPT assets may disposed of by the will of the deceased spouse. A residence owned by a FCPT can qualify as the spouses’ homestead.
Other considerations. A FCPT does not provide asset protection benefits, and may not be a good option if one of the spouses is in a high risk business or profession, or has existing creditors. By comparison, assets owned by a husband and wife as tenants by the entirety are exempt from the claims of the creditors of one of the spouses.
An additional advantage of a FCPT is that it will simplify estate planning for some couples. Today it is often necessary to divide a couple’s assets between them or their revocable trusts in order to maximize their use of the estate and generation-skipping transfer tax exemptions. A FCPT will automatically result in one-half of the trust assets being included in the estate of the first spouse to die.
Untested. Three states (Alaska, Tennessee and South Dakota) already have adopted “opt-in” community property laws. So although Florida would not be the first, be aware that there are no reported cases or IRS Regulations conclusively settling whether a community property trust will obtain the desired tax result for individuals who live in a separate property state.
Leonard J. Adler, Esq. and Mark R. Parthemer, Esq. are both Managing Directors and Senior Fiduciary Counsel of Bessemer Trust, an exclusive wealth management firm for high net worth families. They are responsible for working with clients and their advisors to develop practical and efficient wealth transfer plans and for guiding the firm on fiduciary issues.