If you own property in any of the following states, it is important that you understand the basics about community property: Alaska, Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington and Wisconsin.  Also Puerto Rico and some Indian nations allow property to be owned as community property.  In Alaska, you can choose to have property be community property.  In the other nine states listed above, the community property laws apply automatically.

Community property laws affect married couples who own property in the community property state.  These laws affect property rights of the husband and wife in case of divorce.  They also affect rights of inheritance at death.  They also affect capital gains taxes when the property is sold after death of the husband or wife.

As a general rule, in a community property state, most property bought during the marriage is considered to be community property, and is therefore owned by both the husband and wife, even if title to the property is in the name of only one of them.  However, property that was acquired before the couple was married to each other is separate property, not community property.  Also, property that is given as a gift or inheritance to the husband or wife is separate property.

If the couple gets a divorce, the community property is generally split 50-50 between them.  If one of the couple dies, the surviving spouse can often claim half of the property owned by the one who died, even if his will or trust doesn’t give it to her. The specific laws of each community property state are different from the laws of the other community property states.  If you have a specific question about how community property laws affect your property, you need to find out about the specific laws of the state where the property is located.

One of the most useful things about community property is the affect on the “stepped up basis.”  Let me first review how stepped up basis works in a separate property state like Hawaii.  Suppose you and your spouse bought a vacant lot many years ago for $10,000.  Now, that same land is worth $110,000.  If you sell that land for $110,000, your gain is $100,000 ($110,000 minus $10,000).  You have to pay capital gains taxes on that gain.  The federal capital gains tax rate for property held more than one year is generally 15%.  The State of Hawaii rate is 7.25%.  You would have to pay $22,250 in taxes.  (If you itemize deductions, you can take a deduction the following year on your federal income tax return for the state taxes paid.)  Suppose that instead of selling the property, you hold on to the land until you pass away.  Your spouse inherits your half from you.  Then she sells it for $110,000.  She does not have to pay any capital gains taxes on the half of the property she inherits from you.  When you die owning land, the tax basis in your half changes or “steps up” from $5,000 to $55,000 (the fair market value of your half on the date of death.)  When your spouse sells the whole property for $110,000, her gain and tax on the half she inherited from you is zero.  However, she still has to pay $11,125 in taxes on her own half of the property.

With community property, when one spouse dies, the ­entire property gets a stepped up basis.  The surviving spouse can then sell the property at date of death value, and pay zero taxes!

If you own property in a community property state, it is possible to add to your trust and your spouse’s trust special provisions that retain the community property nature of the property even though you live in Hawaii. Then, if one spouse passes away, the surviving spouse has the tax advantage of a stepped up basis, and can sell the property with no capital gains taxes.