Preserving Community Property Rights in Oregon
Oregon, a common-law property state, is an island surrounded by a sea of community property states: Washington, Idaho, Nevada, and California. Married couples from these states often move to Oregon with substantial assets that they use to purchase real property and other appreciable assets without thinking about tax and ownership issues. Properly managing property purchased in Oregon from proceeds derived from community property is vital in order to ensure that at the death of a spouse the surviving spouse will receive the benefits of community property.
Issues concerning the distinction between community property and common-law property may arise if, for example, a married couple moves from Washington, a community property state, to Oregon and purchases a less expensive home using proceeds from the sale of their residence in Washington. Without proper planning, the married couple may title the new house as tenants by the entirety with the right of survivorship. Additionally, with the excess funds from the purchase of the less expensive home, the married couple may open a brokerage account or purchase stocks as joint owners with a right of survivorship with the same effect. By failing to carefully plan and title their assets, the couple may lose the benefits associated with the community property status of the original asset – their Washington residence. This article will discuss (1) benefits of community property, (2) the legal framework of Oregon’s Uniform Disposition of Community Property Rights at Death Act, and (3) planning considerations to preserve community property.
Benefits of Community Property
For income tax purposes, maintaining the community property nature of a couple’s appreciable assets, such as real property or stock, is important because when one spouse dies all of the couple’s community property receives a full step-up in basis. IRC § 1014(b)(6). The step-up provides the property with a new basis: its fair market value at the date of the decedent’s death. Id.
In contrast, if the property is considered common-law property, only the decedent’s portion of the property receives the step-up in basis, and the surviving spouse’s portion remains the cost basis. For example, in Revenue Ruling 68-80 the taxpayers, a husband and wife, resided and owned real property in a community property state, New Mexico. Rev. Rul. 68-80, 1968-1 C.B. 348. The couple moved to Virginia, a common-law state, and traded their real property in New Mexico for real property in Virginia. The couple took title to the property in Virginia as tenants in common and not as husband and wife. Id. The IRS found that for income tax purposes the character of the community property was lost because the couple converted the property into separate property in a common-law state. Id. The IRS ruled that under IRC § 1014 only the deceased spouse’s one-half interest was entitled to a step-up in basis because the property no longer was community property. Id.
Aside from tax considerations, a married couple may have personal reasons for wanting to maintain the community property nature of their assets. Because each spouse owns a one-half interest in community property, even if property is titled as separate property, the deceased spouse can devise one-half of the community property by will to any person, not solely to his or her spouse. If both spouses are in a second marriage, each may want his or her one-half interest in the community property to pass to children from the first marriages, not to the surviving spouse.
Under the common-law system, if a couple owns property as joint tenants with right of survivorship or as tenants by the entirety, the spouse that dies first would not have the ability to make such a designation. Ownership of the entire property would pass directly to the surviving spouse. Thus, community property may be a great way for persons in a second marriage to ensure that one-half of the property will remain subject to each spouse’s testamentary control.
In general, property acquired in a community property state maintains its community property nature when a couple moves from a community property state to a noncommunity property state such as Oregon. ORS 112.715. Conversely, when one spouse acquires separate property in a state where community property rights do not exist, the separate property does not become community property but remains separate property when transported into the community property state.
Statutory Authority. The Uniform Disposition of Community Property Rights at Death Act (“the Act”), ORS 112.705 through 112.775, provides guidance regarding the disposition of community property and assets purchased using the proceeds from the sale of community property assets. The Act sets out a framework for recognizing and defining the property rights of married persons residing in Oregon who acquired property while they resided in a community property state.
The Act applies to personal property (1) that the couple acquired or that became and remained community property in another state, (2) that the couple acquired using the rents or income from community property or the proceeds from the sale of community property, or (3) that the couple acquired and that is traceable to community property. ORS 112.715(1).
Additionally the Act applies to any real property situated in Oregon (1) that the couple acquired with rent or income from community property, (2) that the couple acquired using the proceeds from the sale or exchange of property that was community property in another state, or (3) that the couple acquired in Oregon that is traceable to community property. ORS 112.715(2).
The Act includes a rebuttable presumption that property acquired by a couple while domiciled in a community property state is subject to the Act and, therefore, is community property. ORS 112.725(1). The Act also includes a rebuttable presumption that the Act does not apply to real property located within Oregon and personal property located anywhere, if the couple acquired the property while domiciled in Oregon and if the title creates survivorship rights for the surviving spouse. ORS 112.725(2). Therefore, if a married couple uses the proceeds from the sale of community property to purchase stock or open an investment account as joint owners after moving to Oregon it would be presumed that they acquired the property as noncommunity property.
Lastly, if the Act applies to the married couple’s property, upon death of a spouse, one-half of the property is the property of the surviving spouse and is not subject to testamentary disposition by the decedent. ORS 112.735. The remaining one-half of the property is the sole property of the decedent and is subject to testamentary disposition or distribution under the laws of succession. Id.
Several strategies will help ensure that a couple’s property will be subject to the Act and maintain community property status: (1) properly title assets so that the property does not lose its community property character, (2) use a joint revocable trust or community property agreement to ensure that the source of funds can be traced, and (3) avoid commingling community property assets with common law property assets.
One of the best ways to maintain the community property nature of the proceeds from the sale of community property is to place the community property into a joint revocable trust with the husband and wife as the trustees. Any assets purchased using the proceeds, including an Oregon residence, should be purchased or acquired in the name of the trust to ensure that ownership of the new assets can be traced back to the community property and to avoid the application of the rebuttable presumption in ORS 112.725(2). Furthermore, Revenue Ruling 66-283 holds that if such a trust is properly drawn, the trust will maintain the community property character of the corpus for income tax purposes. Rev. Rul. 283, 1966-2 C.B. 297.
The married couple should not title property purchased or acquired after the couple moves to Oregon using non-community property assets, such as Oregon wages, into the revocable trust. This will ensure that the couple avoids issues of commingling and makes it easier to determine which assets are community property and should receive a full step-up in basis. Commingling community property assets with noncommunity assets may result in the identity of the community property assets being lost.
Another method for maintaining or establishing community property rights is for the couple to enter into a community property agreement in which they designate specific assets as community property. This type of agreement should effectively maintain the community property nature of any assets acquired by the couple but does not alleviate the need to ensure that the assets are not titled with a right of survivorship to avoid the rebuttable presumption that the property is not subject to the Act.
A community property agreement may not, however, convert any separate property located in Oregon or other noncommunity property state into community property, unless the separate property was acquired using community assets. Additionally, the potential exists that the married couple may commingle these assets with noncommunity property assets.
In Oregon, proper planning is necessary to take advantage of the potential benefits of community property. A practitioner should not rely solely on the statutory presumptions or on tracing rules to establish that a married couple intended to own property in Oregon as community property. It is important to properly title property purchased in Oregon using proceeds from community property to ensure that the community character of the property is not lost. It is also important to prevent the commingling of community property with noncommunity property. Community property agreements and revocable living trusts both serve as useful tools in planning.
© 2008 Kevin J. Tillson