A community property trust (CPT) is a special type of trust that allows married couples to convert their jointly owned property into ‘community property.’ Though this trust structure originates from the community property laws prevalent in nine states in the U.S., a Tennessee Community Property Trust is available for residents of this state, thanks to the distinctive legislation enacted in Tennessee in 2010.
Community property laws deem all property acquired during marriage, with certain exceptions, as equally owned by both partners. When one spouse passes away, the entire property is given a ‘step-up’ in basis, providing significant tax advantages. This ‘step-up’ is what separates community property trusts from typical jointly owned assets, as the latter only gets a partial basis adjustment.
How a Community Property Trust Saves Tax
The primary advantage of a community property trust lies in the tax benefits it offers. Specifically, the ‘step-up’ in basis allows for substantial savings on capital gains tax. Here’s how it works:
When an asset appreciates in value, capital gains tax is owed on the difference between the purchase price (or ‘basis’) and the selling price. A ‘step-up’ in basis adjusts the asset’s cost basis to its fair market value at the date of the owner’s death. Therefore, if an asset is sold after the owner’s death, the beneficiary would owe less in capital gains tax, potentially even zero if sold immediately.
For example, let’s say you and your spouse bought a property in Middle Tennessee for $100,000 and that was included in your community property trust. Fast forward many years later, the property has a fair market value of $500,000. When your spouse dies, if the property is sold at the fair market value, you would pay no sales tax. If the property was sold for $510,000, you would only have to pay taxes on the $10,000.
In a traditional joint ownership scenario, only the deceased’s half of the property receives a ‘step-up’ in basis. However, with a community property trust, both halves of the property receive a ‘step-up,’ effectively reducing the potential capital gains tax if the property is sold later.
The Pros of a Tennessee Community Property Trust
Tax Savings: As discussed, the main benefit of a Tennessee Community Property Trust is the tax savings offered via the full ‘step-up’ in basis. This advantage can lead to significant financial benefits, especially for high-value assets that have appreciated over time. This can be especially true for those who have assets with a high evaluation rate, like real estate or stocks.
Flexibility: Unlike some other trust structures, the trustees retain complete control over their assets while living. They can amend, revoke, or terminate the trust at any time, without needing consent from the other spouse or trustee.
Estate Planning: A Tennessee Community Property Trust is a valuable tool for estate planning, as it enables both spouses to pass their share of the community property to the surviving spouse or any other designated beneficiary without probate.
The Cons of a Tennessee Community Property Trust
Complexity: The rules around community property trusts can be complicated, requiring the expertise of a knowledgeable estate planning attorney. Managing a community property trust can be more complex than other trusts, given the strict requirements on property titling and record-keeping. It can also require the creation of a business entity, like an LLC, if you have out-of-state property. This requirement would make the property owned by an intermediary, and not directly owned by the community property trust.
Cost: The cost of establishing and maintaining a community property trust can be higher than other trusts due to its complex nature. This includes legal fees, administrative expenses, and potentially trustee fees.
Limited Asset Protection and Terms: Community property trusts do not offer as robust asset protection as some other types of trusts. Assets within a community property trust are considered jointly owned, so they may be vulnerable to creditors of either spouse. Also, because of the significant tax advantages afforded to married couples in a community property trust, assets within the trust will have to be split evenly 50/50 in the event of a divorce (absent an apparent agreement inside the trust).
Tennessee Residency: Another downside of the Tennessee Community Property Trust is that at least one resident must be a “qualified trustee,” meaning a resident of Tennessee. For couples residing in Tennessee, this is not much of a concern, but for couples residing outside of Tennessee or in situations in which only one spouse resides here, the necessity of having a qualified trustee potentially poses significant hurdles.
Wrapping It Up
A Tennessee Community Property Trust can be an effective tool for tax planning and estate management, especially for residents in the greater Nashville area who have assets with a higher evaluation rate. However, they also come with potential complexities and costs. As such, it’s crucial to consult with a knowledgeable estate planning attorney to understand if a Tennessee community property trust is suitable for your circumstances. If you are interested in learning more about creating a trust to save on taxes, schedule a free consultation with Crow Estate Planning and Probate by calling 615-558-8002.