Ask Liz Weston

Get smart with your money

community property

Q&A: Do you need a new will when you move to another state?

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Dear Liz: I have a will, properly done by an attorney, in my home state of Texas. I’m thinking of moving to California. Will the state of California recognize and accept my will?

Answer: The short answer is yes, but you should consult a California attorney anyway.

California generally recognizes a will that was valid under the laws of the state where it was executed. But moving to another state can affect other aspects of your estate plan.

Probate in California — which is the court process that typically follows death — can be expensive and protracted. A will doesn’t avoid probate, but a living trust can. The two states also differ in how marital property is treated, even though both are community property states.

Two other documents you should have — a power of attorney for finances and an advanced healthcare directive — also would benefit from updating. These documents allow you to name trusted people to make decisions for you if you’re incapacitated. Having California-specific versions could make it easier for financial institutions and medical providers to accept them. Plus, it’s generally a good idea for the person making healthcare decisions to be physically nearby. That makes it easier for them to get to the hospital in an emergency, consult with doctors and see for themselves how you’re doing.

While you’re at it, take a look at your beneficiary designations for retirement plans, life insurance and other financial accounts. These designations typically override what your will or living trust says, so you’ll want to make sure to review and update those regularly.

As you may have read here before, estate planning is not a “one and done” chore. You should have an attorney review your documents every three to five years and after any major life event, including a move to a new state.

Q&A: Why marriage can reduce taxes on a home sale

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Dear Liz: We are a heterosexual couple who are registered domestic partners in California. We have owned our primary residence for decades. Obviously, its value has increased and is well past the $500,000 home sales exemption limit for couples.

When one of us passes away, how is the basis and the appreciation of the residence calculated for federal and state taxes? Does the step-up basis come into play for both federal and state taxes when calculating capital gains? We do not have any children and are leaving the bulk of our estate to charity.

Answer: California offers the valuable double step-up in tax basis to registered domestic partners, but the federal government does not.

In most states, one half of a couple’s jointly owned property gets a new value for tax purposes when the first partner dies. This step-up in value eliminates capital gains taxes on any appreciation that happened during the deceased partner’s ownership.

In community property states, however, both halves of jointly owned property can get the step-up in value when the first spouse dies. California generally treats registered domestic partners the same as married couples, but IRS Revenue Ruling 2013-17 and Regulation 301.7701-18(c) specify that “marriage” and “spouse” do not include registered domestic partnerships for federal tax purposes, according to Wolters Kluwer Tax & Accounting.

Let’s say you bought the house for $300,000 in the 1980s, invested $100,000 in upgrades over the years and it’s worth $2 million today. The current tax basis would be $400,000 (the sales price plus the upgrades). That’s the amount the two of you would subtract from the sales price to determine the potentially taxable capital gain. You could exempt $500,000 of the home sale proceeds ($250,000 per owner) since you’ve owned and lived in the property at least two of the past five years. That leaves a taxable gain of $1.1 million.

If one of you died tomorrow, only half of the property would get stepped up to the current market value for federal tax purposes while the other half would retain its $200,000 basis for a total basis of $1.2 million. For state tax purposes, both halves would get the step-up so the new tax basis for state taxes would be $2 million.

Something else to consider: a federal law allows the full $500,000 exclusion for surviving spouses if they sell the home within two years of the death. That provision is not extended to registered domestic partners.

As you can see, a marriage certificate could make an enormous difference if the survivor wanted or needed to sell the home after the first death.

Marriage confers a number of other benefits under federal law. A spouse can receive Social Security spousal and survivor benefits, for example, but registered domestic partners aren’t eligible for benefits on a partner’s earnings record. Spouses also have special rights with IRAs and employer retirement plans, such as being able to treat an inherited IRA as their own. Non-spouse beneficiaries, including domestic partners, generally must empty the accounts within 10 years.

Your mileage may vary, but the benefits are numerous and valuable enough to make marriage worthwhile in many cases. Please talk to your tax pro and estate planning attorney for individualized advice.

Q&A: Is a spouse responsible for a cosigned loan?

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Dear Liz: Before we were married, my spouse co-signed for two student loans for a relative. The loans have not been paid off. Occasionally the former student is late and my spouse is contacted. If I survive my spouse, who has end stage kidney disease, will I be responsible for the debts if the relative defaults?

Answer: Because your spouse co-signed the loans before marriage, the debt isn’t considered community debt. In other words, you can’t be held directly responsible if the relative defaults.

Unpaid student loan debt could become a claim against your husband’s estate, however. Some lenders might push to get reimbursement this way, while others won’t. Creditors typically have a limited period in which to make such claims (the period varies by state).

To complicate matters further: some older student loans have automatic default clauses that make the entire balance due if a co-signer dies. That means the lender could demand immediate repayment from the relative and from your spouse’s estate. It would be smart to check the promissory note to see if it contains such language. If it does, the relative can ask the lender or lenders about a “cosigner release,” which would remove your spouse’s name from the debt. Another and even better option would be for the relative to refinance the loans in their own name if possible.

An estate planning attorney can help answer your questions about the potential impact of these loans as well as other steps you can take now to protect your spouse’s estate.

Q&A: Should I get a home appraisal when my spouse dies?

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Dear Liz: When one spouse dies, the couple’s primary residence gets a step-up value to the current market value (in California). So how is that value established for future reference? Is it necessary to get a formal appraisal or are current sales comparisons sufficient? Also, is that step-up value the basis for any future home sale or would the sale have to happen in a certain time frame?

Answer: It’s a good idea to get a formal appraisal after a spouse dies to establish the home’s value and potentially reduce future taxes. There’s no deadline for using this new tax basis, but surviving spouses who sell within two years of the death can get the full $500,000 capital gains exclusion available for couples. After the two-year mark, survivors would be limited to the individual $250,000 limit.

Here’s a quick primer on how step-up works. In every state, the deceased spouse’s half of jointly owned property gets a new value for tax purposes. This step-up in tax basis means that no capital gains taxes will be owed on the appreciation that happened during the deceased spouse’s ownership, at least on 50% of the property.

In community property states, both halves of the property typically get this valuable step-up in basis at the first spouse’s death. Community property states include Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington and Wisconsin.

If an appraisal wasn’t ordered soon after a death, getting a formal valuation can be somewhat more complicated. Your estate planning attorney may be able to guide you to appraisers experienced in retrospective valuations.

Q&A: Does my spouse get half of everything in a divorce?

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Dear Liz: My wife recently asked for a divorce, which was difficult to hear. That said, I want to move forward with my life and part of this is being on sound economic footing. I have been the primary earner in our marriage for most of our 12 years together, even though my wife was capable of working full time. Since we live in California, does she get 50% of everything, including money I had prior to our marriage? And if I originally put in only one-third of the down payment on our house, am I only eligible for one-third of the appreciation, or do I get half?

Answer: Even in community property states such as California, assets acquired before marriage are typically considered separate property. Assets acquired during the marriage, however, are generally split 50/50. If you can trace your down payment back to your separate property, you may be able to get a reimbursement for that amount before the remaining equity is split between you. Your attorney can offer further guidance.

Q&A: Future mate hasn’t filed tax returns. Am I liable?

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Dear Liz: I’m engaged to someone who just confessed that they have not filed tax returns for the last several years. How do we fix this? If they owe a lot of money, could the IRS come after me if we’re married?

Answer: Technically, debts incurred before marriage are considered separate. But there are many ways premarital debt can affect postmarital life.

If you live in a community property state, for example, creditors could come after jointly owned assets if your spouse fails to pay what they owe. Your spouse’s debt could affect how much you two can borrow if you want to apply for a mortgage or other joint obligation. And the money your spouse uses to pay off the debt isn’t available for other uses that could benefit both of you. That could include everything from paying bills to going on vacation to saving for retirement.

The IRS is not a good creditor to have, in case you had any doubts. The agency has many enforcement powers, such as withholding refunds, taking part of someone’s paycheck and seizing property to pay debts. Consider working with a tax pro to get the missing returns filed as quickly as possible. The IRS also offers payment plans for those who can’t pay in full.