Trusts are an effective way to protect your assets as you age. However, if you are a married couple looking to safeguard your assets in the event one of you passes away, a standard trust may not be enough to prevent the other from owing significant capital gains taxes. A Tennessee Joint Community Property Trust (“Joint Community Property Trust”) offers specific benefits designed to help ensure that your marital assets continue to provide for the surviving partner.
In this article, we’ll explore what a community property trust is in Tennessee, how it works, and the advantages it provides in passing on the value of shared assets.
What is Community Property?
For many years, it has been the law that when a person inherits property, either personal property or real property, in most cases, he or she receives the property with a “step-up” in the property’s basis for capital gain recognition. When their child inherits their parent’s property, the property’s basis is stepped-up to its value at the decedent’s date of death. All the gain that accumulated in the property while owned by the parent evaporates and is not taxed.
Similarly, when the first of a married couple dies, and the survivor inherits the decedent’s portion (usually half) of a property, normally, the survivor receives a “step-up” in just the decedent’s half of the property’s basis for capital gain recognition. The basis of the portion owned by the survivor remains at its original amount. If the survivor sells the property immediately, there will be a gain to report, which is calculated as the property’s sale price minus the survivor’s basis in the property’s.
In short, without community property, the survivor must deal with larger capital gains tax burdens while missing out on significant capital gains that could help support them.
This is where community property comes into play. Under Section 1014 of the IRS Code, property held jointly by a married couple as community property receives a full step-up in basis at the first death of the couple, both (i) for the inherited portion, and (ii) the portion originally owned by the survivor.
Using the above example, with the new trust, the survivor’s portion also receives a step-up in basis. Therefore, if the property is sold by the survivor immediately, there is no gain to report. If the survivor sells the property later when its valuation has risen, there will be a gain, though not as much to report as in the instance of the half step-up.
Is Tennessee a community property state?
There are currently nine states that are “community property” states, mostly in the western part of the country. Tennessee is not a community property state. However, in 2010, Tennessee joined a few other states in the creation of community property trusts, which offer married couples the full advantages of a community property step-up in basis.
While Tennessee does not have community property, a Tennessee Joint Community Property Trust expands the idea of a step-up in basis from just the decedent’s portion to include the portion owned by the survivor. This technique can apply to all types of assets, including real property, investments, and business interests. The Joint Community Property Trust essentially discards any potential capital gain not yet recognized when the first of the couple dies.
Even though Tennessee is not a community property state, through the use of the Joint Community Property Trust, people in Tennessee can essentially convert property contributed to the trust to community property and receive the full step-in basis along with numerous other tax benefits in the event of a spouse’s passing. Since the state recognizes Joint Community Property Trusts, reaping the benefits of community property in Tennessee is, essentially, an opt-in affair.
Benefits and Drawbacks of a Tennessee Joint Community Property Trust
The most notable advantage of opting for a community property trust is that when the first spouse dies, both spouses’ interests in the community property, not just the decedent’s interest, receive a step-up in basis for income tax purposes, up to the fair market value price. In this way, the living spouse may pay little to no taxes or could sell tax-free, depending on the setup of the trust.
There are also gift and estate tax benefits, too. A sizable asset to this type of trust is that it allows the couple to utilize their death tax exemptions. By doing so, when one spouse dies, his or her half is passed on by a will and the living spouse’s half becomes his or her property outright.
This also plays into another benefit: because each spouse owns an undivided one-half interest in all community property, each half may be eligible for a discount in value for transfer tax purposes.
Though the benefits are many, there are a few potential risks to creating a Tennessee community property trust as well. For example, spouses need to read the fine print to ensure that if death occurs, the trust does not have a fine line benefiting one over the other.
Other potential risks associated with Tennessee Joint Property Community Trusts include:
- As mentioned above, if a divorce occurs, the way assets are distributed can change.
- A Tennessee resident or financial institution in the state is required to serve as a Trustee while both spouses are alive.
- Property may be subject to creditor claims against either spouse.
How to Create a Tennessee Joint Community Property Trust
In order to reap the benefits of a community property step-up in basis in Tennessee, your trust must meet four requirements, as explained by the Tennessee Bar Association:
- “a declaration that it is such;
- at least one “qualified trustee,” meaning a Tennessee resident or bank qualified in Tennessee;
- signatures of both spouses; and
- specific “warning” language in capital letters at the beginning of the trust instrument.”
Understanding the Features of a Tennessee Joint Community Property Trust
These are some of the features of the Joint Community Property Trust:
- It is a revocable trust.
- It is only for a married couple.
- It is one trust for a married couple, rather than each of the couple having his or her own separate trust.
- Each of the couple is a Grantor of the trust.
- Each of the couple is a Trustee of the trust.
- There is no separate accounting of who of the couple contributed which property to the trust.
Contact a Nashville Trust Attorney for Assistance
Navigating the various trusts that are available can be overwhelming. This is why it’s important to work with a trust attorney you can trust to help you throughout this process. The attorneys at MHPS are available to answer any questions you may have about Tennessee Joint Community Property Trusts or estate planning in general.
Contact us today to learn more about your options for community property trusts in Tennessee.
