What is a Community Property Agreement?

A Community Property Agreement is a contract that a married couple in a community property state sign as a couple that specifies how they want their property to be classified. Classification may be as community property or separate property, or a mix of the two. It is very important that couples in community property states take advantage of the opportunity to prepare a Community Property Agreement. Otherwise due to the complexity of the law, it can be very difficult to know exactly how your property is classified, and unless you know how it is classified you cannot know with certainty how it will pass at your death.

As stated in Chapter One, the fundamental principal in estate planning is that a person may only transfer what he or she owns. In a community property state, a married person owns only one-half of the community property and all of his or her individual property. Distinguishing community property from individual property can be a rather complex exercise.

Community property states use a complicated formula used to determine how much of a mixed property account balance is community and how much is individual. This formula is applied at the first spouse’s death to determine how much of the mixed property account belongs to the surviving spouse as community property. This calculation is critical for estate planning purposes because the deceased spouse is legally entitled to pass on only his or her own property to beneficiaries other than the surviving spouse.

The complexity of these issues frequently cause Community Property Agreements to be used to classify in advance all of the couple’s property as individual or community in order to simplify the process at the first spouse’s death and save costs. There are pros and cons to classifying property as individual or community and deciding which classification is best often entails an asset-by-asset inquiry by an experienced estate planning attorney.

One advantage of classifying your property as community is that it will receive the beneficial double step-up in its tax basis at the first spouse’s death, but there are other factors to consider. In some cases, a couple may want to forgo the capital gains tax benefits of community property and instead classify property as individual to accomplish other estate planning goals. Such possible goals could include the following:

• They wish to provide for children of a prior marriage;
• One spouse has a large family inheritance; or
• One spouse has exposure to creditor claims and wishes to protect the other spouse from such claims.

In summary, a sound estate plan for married couples must always take into account the specific laws of the state they live in. There are important estate planning decisions that must be made whether one lives in a separate property state, or in a community property state. Your estate planning attorney can assist you in explaining these complicated matters to help you maximize your estate planning opportunities and give you confidence that you know exactly how your estate will pass at your death.