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San Antonio Express-News
September 10, 1999

Community Property Created by Agreement

© 1989-2004, Paul Premack

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Dear Mr. Premack: Last week you gave us an overview of several new laws. One of them was about changing separate property into community property. A few years ago I inherited a rent house, which is my separate property. Why would I want to make it into community property? Is there an upside, and is there a downside to making the change? – A.D. via Email

Texas law has, for more than 100 years, distinguished between community and separate property. Separate property includes anything 1) owned before your marriage, 2) received by gift or inheritance during your marriage, or 3) you and your spouse agree (in writing) is separate property.

Now, if approved by the voters in the November 2 election, spouses will be able to take exactly the opposite approach by changing separate property into community. The new law will be effective on January 1, 2000 as part of the Texas Family Code if approved by the voters.. But, as you ask, why would someone make this change?

There are a few reasons that you may NOT want to make the change. For instance, separate property is under your sole management and control. If your spouse has debts, your separate property is probably unreachable by those creditors. If you are divorced, your spouse should have no claim to your separate property. If you die, you can easily pass your separate property to your children instead of to your spouse.

On the other hand, the desire to convert assets into community property is largely tax motivated. Because community property is owned 50-50 by each spouse, the taxable estate of each spouse is equal. As a result, it is easier to legally reduce or eliminate federal estate taxes.

For instance, if one spouse owns separate property worth $1 million, and the other spouse’s assets are worth $100,000, there may be a higher estate tax if the wealthier spouse dies second. This is because the less affluent spouse cannot fully utilize the federal unified credit (which currently eliminates estate tax on up to $650,000).

To save taxes, the spouses can balance their ownership interests. The wealthier spouse, in the above example, could give $450,000 to the less affluent spouse (without worrying about gift tax.) They would then each own estates valued at $550,000 and could legally eliminate estate taxes when they die. However, under the old law, since the assets started out as separate property, they remained separate property (even though they may have been owned jointly by both spouses).

The basis of separate property is not treated as favorably as is community property when a spouse dies. When separate property is inherited, only the separate property is assigned a stepped-up basis. In the example, only the $550,000 owned by the first to die is given a new basis. The basis of the other half stays at whatever level it already had, so when it is sold the capital gain taxes may be significant.

On the other hand, all community property is given a fully stepped-up basis when one spouse dies. As a result, then entire $1.1 million would be assigned a new basis. If the survivor elects to sell any investments, there could be a substantial reduction or elimination of capital gain taxes. These "upsides" and "downsides" will affect different couples in different ways. You should consult with your attorney to see what the effects would be for you.

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Disclaimer: This column answers a specific legal question offered by an individual in the South Texas area. The answer may or may not match your individual situation. Be careful not to treat this column as specific legal advice that meets your individual needs. It may give you a solid basis for discussion with your own attorney. Also, please be aware that laws change. You should consult with your personal attorney before you take any action on this or any legal issue.

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