I had the wonderful opportunity of attending the Fifth Annual Sun City West Financial Forum the other night. It was wonderful to be a small part of such a great event that the Investment Club of Sun City West puts on. As I was standing at by booth it seemed that the number one question that kept being asked of me, over and over again, was about whether to create an estate plan in Arizona or another state. The conversation would always start off with, “I live in Arizona part of the time and in _____________, (you fill in the other state), the other part. Where should I have my estate plan done?” My answer was always the same- “Arizona is the best place to create your estate plan because this is the Wild West and anything goes.”
It is true this is the Wild West, but truthfully the best reason to do your estate plan in Arizona is because Arizona is one of only 9 states that is a community property state. The other community property states are: 1)California, 2)Nevada, 3)New 4)Idaho, 5)Washington, 6)Wisconsin, 7)Texas, and 8)Louisiana. So why is creating your estate plan in a community property state such a big deal you may ask. The main reason is because when you die we want to avoid paying any unnecessary taxes. There are all sorts of taxes that you need to be aware of-income tax, inheritance tax, gift tax, estate tax, generation skipping transfer tax, state estate tax, excise tax, capital gains tax. The one that we are concerned with avoiding when we talk about a community property state versus all other states, which are what we call separate property states, is the capital gains tax.
In a community property state we are able to wipe out any capital gains tax because we get 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 say that you bought some property in Arizona back in 1970 as an investment for $10,000 and today, in 2012, that same piece of real estate is now worth $110,000. Your original cost basis in the property is $10,000 and it has now appreciated to $110,000. You have a $100,000 gain in the property. If you sale 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 she would not have to pay any capital gains tax on it. This is because the IRS would have allowed her to step up the cost basis in the property from the original $10,000 cost basis in 1970 to the date of death cost basis of $110,000, effectively wiping out any gain in the property. Because there is no gain in the property from the date of death stepped up value to the date it is sold by the surviving spouse there is no tax that needs to be paid.
How would this same scenario play out in any other state that is not a community property state? When the first spouse died in 2012, just like above, 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 in 2012 it is worth $110,000, which means a $100,000 gain. In a separate property state the survivor only gets a step up in basis of $50,000 and therefore has to pay capital gains tax on the other $50,000. This is not great planning.
If you can choose between having your estate plan done in a community property state versus a separate property state you should choose community property every time. The attorneys at the law firm of Morris Hall have been practicing in estate planning for 42 years. We would love to help you create your estate plan in the wonderful Wild West state of Arizona.