Retaining the community property nature of assets can be quite beneficial from an income tax standpoint. Under the Internal Revenue Code when an individual dies his or her interest in both real and personal property receives, in most cases, a new income tax basis equal to their fair market value as of the date of death. In separate property jurisdictions, states which are not community property states, only the interest of the decedent in most assets receives a new income tax basis at death. However, in community property jurisdictions, not only does the decedent’s one-half interest in a couple’s community property receive a new income tax basis but the surviving spouse’s one-half interest in the community property assets also receives a new income tax basis. The following example illustrates the different income tax basis results for couples living in separate property states and those living in community property states:
Bob and Sarah, both lifelong residents of Oregon, purchased 1,000 shares of ABC, Inc. stock in 1990 for $15/share. Bob and Sarah equally contributed towards the $15,000 purchase price with earnings from their employment. In 2014, when the stock is selling for $100 per share, Bob dies. Under the Internal Revenue Code, because Bob and Sarah were always residents of Oregon, a separate property jurisdiction, only Bob’s one-half interest in the stock will receive a new income tax basis equal to $50,000. Sarah’s tax basis of $7,500 (her one-half of the cost) remains unchanged. If Sarah sells all 1,000 shares of ABC, Inc. stock at the $100 per share value, she would recognize $42,500 of capital gains tax.
Assume the same facts as above, except that Bob and Sarah purchased the ABC, Inc. stock in 1990 while residents of California and then moved to Oregon and 2012 after their retirement. On Bob’s death in 2014, not only will Bob’s one-half community property interest in the stock receive a new income tax basis of $50,000 but Sarah’s one-half community property interest in the stock will also receive a new income tax basis of $50,000. As such, if Sarah sells all 1,000 shares of the ABC, Inc. stock at $100 per share, she will not recognize any taxable gain.
As demonstrated above, it is very important for couples relocating to Oregon from a community property state to, if at all possible, retain the community property character of their assets. To help preserve the community property nature of assets our clients bring to Oregon from community property states, our firm has (i) these clients enter into a property agreement ratifying the community property status of their assets, and (ii) these couples carefully document the community property origin of their assets, whether the assets are located within Oregon or elsewhere. This tracing can be very important at a later point in time to help substantiate the status of assets as community property, especially if the asset has changed form or been converted into other assets.
Read Part 1 of this post by clicking here.