If you must choose between having your estate plan prepared in a community property state or a separate property state, you should choose community property every time. Arizona is one of only nine community property states. The other community property states are: 1) California, 2) Nevada, 3) New Mexico, 4) Idaho, 5) Washington, 6) Wisconsin, 7) Texas, and 8) Louisiana. The main reason to do your estate planning in a community property state is to minimize taxes.
There are all sorts of taxes that you need to be aware of when establishing an estate plan, they include income tax, inheritance tax, gift tax, estate tax, generation skipping transfer tax, state estate tax, excise tax, and capital gains tax. Doing your estate planning in a community property state can significantly decrease and often times even eliminate the amount of capital gains taxes when death occurs.
In a community property state, capital gains tax on community assets can be eliminated by receiving a full step up in tax basis when a loved one dies. I think an example would best illustrate what I mean by a step up in tax basis. Let’s assume that you and your spouse purchased some property in Arizona back in 1970 as an investment for $10,000. That initial $10,000 payment is what the IRS calls your cost basis in the investment. Let’s say that same community asset is worth $110,000 today. Your original cost basis in the property is $10,000, but now that it has appreciated to $110,000, you have a $100,000 gain in the property. If you sell the property this year for $110,000, then you owe a capital gains tax on the $100,000 gain. In the alternative, had you not sold the property this year, but instead held on to it and died this year leaving it to your spouse, and then your spouse sold it for the $110,000, he/she would not have to pay any capital gains tax. In this scenario, the IRS would have allowed the surviving spouse to step up the cost basis in the property from the original $10,000 cost basis in 1970 to the date of death fair market value of $110,000, effectively wiping out any gain in the property.
How would this same scenario play out in any other state that is not a community property state? When the first spouse dies the surviving spouse only gets a half step up in tax basis on the property. Remember the original cost basis was $10,000 in 1970 and now today it is worth $110,000, which means a $100,000 gain. In a separate property state the survivor would only get a step up in basis on half the value ($50,000) and therefore would have to pay capital gains tax on the other half ($50,000). This is not great planning.
In addition to receiving a full step up in basis, Arizona currently does not have a state estate tax or inheritance tax. Although these tax advantages may change in the future, their present benefits make Arizona a great state to die in.
The attorneys at Morris Hall, PLLC have been practicing estate planning for over 40 years. We would love to help you create your estate plan in the wonderful Wild West state of Arizona.
Contributed by Morris Hall, PLLC Arrowhead, Phoenix and Scottsdale Estate Planning Attorney and Partner, David T. Eastman.
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This blog should be used for informational purposes only. It does not create an attorney-client relationship with any reader and should not be construed as legal advice. If you need legal advice, please contact an attorney in your community who can assess the specifics of your situation.