Tennessee Community Property Trust: Full Step-Up In Basis At First Death

Posted by Martin Heller Potempa & Sheppard, PLLC on October 14, 2021

In 2010, Tennessee enacted a law that allows for the creation of a new type of trust designed to reduce a couple’s future capital gain taxes for the survivor of a couple after the first one dies. This new trust is called a Tennessee Joint Community Property Trust (“Joint Community Property Trust”) and expands the idea of a step-up in basis from just the decedent’s portion to include the portion owned by the survivor. This technique can apply to all types of assets including real property, investments, and business interests. The Joint Community Property Trust essentially throws away any potential capital gain not yet recognized when the first of the couple dies.

There are currently nine states that are “community property” states, mostly in the western part of the country. Under Section 1014 of the IRS Code, property held jointly by a married couple as community property receives a full step-up in basis at the first death of the couple.

Even though Tennessee is not a community property state, through the use of the Joint Community Property Trust, people in Tennessee can essentially convert property contributed to the trust to community property and receive the full step-in basis.

These are some of the features of the Joint Community Property Trust:

  • It is a revocable trust.
  • It is only for a married couple.
  • It is one trust for a married couple, rather than each of the couple having his or her own separate trust.
  • Each of the couple is a Grantor of the trust.
  • Each of the couple is a Trustee for the trust.
  • There is no separate accounting of who of the couple contributed which property to the trust.

Below is a description of what normally happens in current practice and what can happen when you use the new trust.

 1. Step-Up In Basis – In General

For many years, it has been the law that when a person inherits property, either personal property or real property, in most cases, he or she receives the property with a “step-up” in the property’s basis for capital gain recognition.

For instance, assume Parent bought something for $1,000. For future capital gain calculations, the $1,000 purchase price is the Parent’s “basis” in the property. Years later, Parent sells it for $5,000. Parent has a gain to report of $4,000, which is calculated as the property’s sale price ($5,000) minus the Parent’s basis in the property ($1,000).

When a person inherits property, the property’s basis is stepped-up to its value at the decedent’s date of death. Using the above example, assume Parent does not sell the property, but instead keeps the property and dies when it is valued at $5,000. The Child inherits the property. Child now owns the property with a stepped-up basis of $5,000 for future gain calculation. Later, the property’s value increases to $6,000, and Child sells the property. Child reports a gain of only $1,000 calculated as the property’s sale price ($6,000) minus Child’s basis in the property’s ($5,000). All the gain that accumulated in the property while owned by Parent evaporates and is not taxed.

2. Half Step-Up In Basis – What Normally Happens for a Married Couple

When the first of a married couple dies, and the survivor inherits the decedent’s portion (usually half) of a property, normally, the survivor receives a “step-up” in just the decedent’s half of the property’s basis for capital gain recognition. The basis of the portion owned by the survivor remains at its original amount.

For instance, assume Couple bought property for $1,000. For future capital gain calculations, the $1,000 purchase price is allocated half ($500) to one of the couple and the other half ($500) to the other of the couple. When the first of the couple dies, the survivor inherits the decedent’s half of the property. At this time, the value of the whole property has risen to $5,000.

In this situation, the basis of the survivor’s inherited half of the property is stepped-up to its date of death value. In this situation, half the value of the property is $2,500. Now, the survivor’s basis in the whole property is equal to the total of (i) the survivor’s basis in his/her original half the property ($500), and (ii) the survivor’s stepped-up basis in his/her inherited half of the property ($2,500), for a total basis of $3,000. If the survivor sells the property now when valued at $5,000, there will be $2,000 of gain to report, which is calculated as the property’s sale price ($5,000) minus the survivor’s basis in the property’s ($3,000). If the survivor sells the property later when the value increases to $6,000, the gain to report is $3,000 calculated as the property’s sale price ($6,000) minus the survivor’s basis in the property ($3,000).

3. Full Step-Up In Basis – Joint Community Property Trust for Married Couples

The Joint Community Property Trust is designed to provide the survivor of the couple with a full step-up in basis, both (i) for the inherited portion, and (ii) the portion originally owned by the survivor.

Using the above example, with the new trust, the survivor’s portion also receives a step-up in basis of $2,500, which is half of the date of death value. The result is the survivor’s basis in the property is now a full $5,000. Therefore, if the property is sold by the survivor for $5,000, there is no gain to report. If the survivor sells the property later when valued at $6,000, the gain to report is $1,000, which is calculated as the property’s sale price ($6,000) minus the survivor’s stepped basis in the property ($5,000) for a reported gain of $1,000.

Contact a Nashville Trust Attorney for Assistance

Navigating the various trusts that are available can be overwhelming. This is why it’s important to work with a trust attorney who will help throughout this process. The trust attorneys Martin Heller Potempa & Sheppard, PLLC can answer any questions about trusts or estate planning that you have.

Contact us today to learn more.

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