Community Property: Uncover Hidden Tax Benefits
A special tax law, 'Community Property,' is available only to married couples in 9 U.S. states. By treating assets and income during marriage as jointly owned, you can achieve significant savings on income and inheritance taxes. Use this guide to understand the principles and find your benefits.
Community Property States
Alaska, South Dakota, Tennessee, Kentucky, and Florida have 'opt-in' systems where couples can agree to have their property treated as community property.
Benefit 1: Income Tax Savings Through Income Splitting
When there's a large income gap between spouses, community property becomes a powerful tax-saving tool. By splitting the total income in half when filing 'Married Filing Separately,' you can avoid higher progressive tax rates. See the potential savings with the simulator below.
Estimated Federal Income Tax Savings
$2,740
Note: This calculation is an estimate based on 2024 federal tax rates and standard deductions. Actual tax liability may vary. Filing 'Married Filing Separately' may limit certain deductions. Consult a tax professional.
Benefit 2: Eliminating Capital Gains Tax on Inheritance
One of the most powerful benefits is the 'Double Step-Up in Basis.' Upon a spouse's death, the cost basis of the entire community property asset is stepped up to its fair market value, potentially eliminating all capital gains tax for the surviving spouse upon sale.
Common Law State
Only the deceased spouse's half (50%) gets a step-up.
New Cost Basis: $600,000
Taxable Capital Gain: $500,000
Estimated Capital Gains Tax (15%)
$75,000
Community Property State
The entire property (100%) gets a full step-up.
New Cost Basis: $1,100,000
Taxable Capital Gain: $0
Estimated Capital Gains Tax
$0
Understanding Key Concepts
To fully leverage the tax benefits, you must accurately understand the basic terminology of the community property system.
Property Classification: The Starting Point
Community Property
All property acquired during the marriage while living in a community property state. It's considered jointly owned, regardless of whose name is on the title.
- House bought with salary earned after marriage
- Joint savings account
- Assets of a business started after marriage
Separate Property
Property owned by either spouse before the marriage, or property acquired by one spouse through gift or inheritance during the marriage.
- Apartment owned before marriage
- Land inherited from parents
- Cash received as a personal gift
Income Classification: The Basis for Tax Reporting
Community Income
Income from community property and all income earned through the labor of either spouse during the marriage. It is split 50/50 regardless of who earned it.
- Salaries, bonuses, and business income
- Rent from a jointly owned building
Separate Income
Income generated by separate property. This income belongs to the spouse who owns the property.
- Dividends from inherited stock
- Note: Some states (ID, LA, TX, WI) treat income from separate property as community income.