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The Heckerling institute for Estate Planning has been holding its annual conference this week and a topic discussed frequently amongst colleagues was the Florida Community Property Trust Act enacted by Florida’s State Legislature last summer. We thought it would be a good opportunity to review the pros and cons.
Florida, a separate property state, has a new set of rules allowing married couples to opt-in to community property treatment via trust. This is important because property that is community property receives a step-up in tax basis upon the death of the first spouse. Married couples may now have an additional tax planning opportunity – no matter where they live in the United States. This post will provide some background on community property in the United States, will explore the benefits of community property treatment, and will explain the potential pitfalls associated with planning under the new Florida rules.
Locally, Maryland, D.C., Virginia are “separate property” states. Only eight states apply “community property” rules. These are: Arizona, California, Idaho, New Mexico, Louisiana, Texas, Nevada, and Washington. Alaska, Kentucky, Tennessee, and South Dakota are “separate property” states that allow married couples to opt-in to “community property” treatment. Alaska, Tennessee, and Kentucky also allow non-residents to utilize their community property rules (as does the new Florida law). “Community property” and “separate property” impacts the way property is divided at death and in divorces and has implications for tax and creditor purposes.
What is the advantage? The great thing about community property is that under IRS rules, property treated as community property receives a step-up in basis to the full extent of such property upon the death of the first spouse. This is true whether only a portion of such property was includible in the taxable estate of the first deceased spouse. This means that when the surviving spouse sells these assets, he or she will be responsible for less income tax on the disposition. The new Florida rules gives Florida residents and non-residents alike the ability to establish a community property trust (or to decant an old trust into a community property trust) after July 1, 2021. This means that Florida residents and non-residents alike have an additional tax planning tool available to them. To use the new Florida rule, the trust must have a “qualified trustee”, which is defined to be a Florida resident who is a person (not an entity) or a company “authorized to act as a trustee” in Florida. Florida Trust Code Section 736.1502.
What are the pitfalls? Upon the death of the first spouse, one-half of the Florida community property trust property may be disposed of as such spouse directs, and the surviving spouse may do as he or she wishes with the balance. Florida Trust Code Section 736.1507. This differs from property held with a spouse as tenants by the entirety or as joint tenants with rights of survivorship. With this ownership, property automatically passes to the surviving spouse. This is also different from property held in a joint irrevocable trust by spouses, where the surviving spouse is protected knowing that the plan for the property at the first death will remain unchanged. In this way, the Florida community property trust protects a surviving spouse than may be desired.
And like the death rule, upon divorce, one-half of the property in the community property trust defaults to belonging to each divorcing spouse, and a prenuptial or postnuptial agreement may not be effective to alter this result. Florida Trust Code Section 736.1508. This would produce a negative result if property not subject to division on divorce under a prenuptial agreement is used to fund the community property trust (because it would be converted to property subject to division).
The Florida community property trust has another downside: a loss of creditor protection. For example, property held between married people as “tenants by the entirety” will be protected from the creditors of one spouse. Once transferred into the community property trust, however, the creditors of one spouse can reach one-half of the trust assets, whether those assets were once held as tenants by the entirety. Florida Trust Code Section 736.1506. Note, however, that Florida property homestead protections remain for homestead property transferred to such trust. Florida Trust Code Section 736.151.
Consider whether the benefits associated with transferring property into a Florida community property trust outweigh the risks. This will depend on each couple’s financial situation and relationship with each other. Note that the appeal of this trust stems largely from its tax treatment, but even that is uncertain. Although property held as community property receives a full step-up in basis upon the death of the first spouse, questions remain as to whether this holds true even when a couple opts-in to the community property trust treatment (rather than being forced into community property treatment under the laws of the state). There is no case law on this point. Contact us to discuss the advantages of this recent Florida law.
Contributed by Coryn Rosenstock, Esq., Director, Altman & Associates