California Property in South Carolina (and Taxes)
Actually, it could be property from any of the following 9 states:
Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington and Wisconsin.
These are called community property states, with South Carolina and the rest of the United States generally being separate property states.
Although it’s not quite this simple, community property is essentially property acquired by 2 people while living in one of the above states while married to each other, and carries with it various rights.
Why You Should Care . . .
Community Property Brought to a Separate Property State
Generally, community property acquired while a couple resides in a community property state maintains its character as community property even if the couple moves to a separate property state, like South Carolina. And, even after the taxpayer is residing in a separate property state, the purchase of assets traceable to community property assets will still be considered community property. That is, if the funds in your brokerage account are community property and you bought rental property using those funds, the rental property in SC would be community property.
Don’t Blow Up the Double Step Up
For community property, in contrast to separate property states, there is a double step up in basis on the first death. For example, if a husband and wife have a joint brokerage account or rental property worth $500,000 and a basis of $200,000, after the first spouse dies, the new basis for the surviving spouse is $500,000, because both the deceased spouse’s share and the surviving spouse’s share are stepped up to fair market value. If the surviving spouse then sold these assets, there would be no gain, so no tax!
In a separate property state, however, for joint owners of an appreciated asset, there is only a single step-up in basis when the first person dies. Using the previous example, the new basis for the surviving spouse is $350,000, because only the deceased spouse’s share is stepped up. If the surviving spouse then sold these assets, there would be tax on the $150,000 gain.
Therefore, serious care should be taken to preserve the community property nature of assets for people moving to SC from a community property state. People moving here from a community property state are unlikely to know that they even own community property. You might have a married couple, lifelong residents of Texas, who decide to retire in South Carolina. Little do they know that after they arrive in SC, they buy property and retitle it in a way that converts it to separate property, thus destroying the double step up. Or, after moving here they continue contributing to their investment account with their new contributions potentially converting the account into separate property or a portion thereof. Or, they stop contributing to this account but the earnings in the account, considered separate property, are kept in the account and become commingled with the rest of the existing account. In all of these situations, the double step up can be compromised.
When you Might Want to Blow Up the Double Step
Sometimes achieving the opposite, though, can actually be beneficial. That is, intentionally trying to convert community property into separate property can be advantageous:
Many clients wish to sell assets to intentionally obtain a loss to offset against capital gain and income. If clients die with community property that has decreased in value, there is a double step down in basis, which can wipe out any losses clients wish to create. So, for many it might make sense to convert community property into separate property to prevent this double step down.
You might deal with people who have moved from one of the 9 states mentioned above. They might have recently moved here or have been residents of SC for years. Being aware from what state your client has moved from can put you in a position to better tailor your advice to your client’s needs. You will be doing your clients a huge service in properly identifying these people as well as their assets relevant to this issue.
Contact Hamrick Law in Greenville, SC for business planning and estate planning!
** Disclaimer – This is very simplified. There are many additional issues to address on this specific topic but only so much can be said in a short amount of space. This is not intended as legal advice. As always, you should not act upon any such information without first seeking qualified professional counsel on the specific matter.