Tennessee Community Property Trusts
A Tennessee community property trust is a special type of trust that allows spouses to convert individually or jointly-owned property to community property. We recently posted a series on the basic forms of joint property ownership in Tennessee.
In this series we briefly touched on some of the potential benefits of married couple holding community property in Tennessee.
Here’s the skinny…
In 2010 Tennessee enacted the Tennessee Community Property Trust Act of 2010 which allows married couples to convert their property to community property by transferring it to a Tennessee community property trust.
The primary benefit of owning community property is that upon the first spouse’s death, both spouses’ ownership in the community property receives a step up in basis to the fair market value of the property. If the surviving spouse subsequently sells the community property there are no capital gains.
Other potential benefits of a Tennessee community property trust include the ability to easily equalize asset ownership between spouses and to receive valuation discounts for fractional ownership of real property or closely-held business interests.
Proceed with caution because there are some cons associated with a Tennessee community property trust.
First, converting tenancy by the entirety property to community property may subject the property to creditor claims against either spouse.
Second, a Tennessee community property trust could affect how assets are distributed in the event of a divorce. The statute even requires the trust instrument itself to include a disclaimer IN ALL CAPS to this effect.
Third, a Tennessee resident or Tennessee chartered financial institution must serve as trustee while both spouses are living.
To my knowledge there have been no challenges by the IRS to Tennessee’s elective community property system. The general consensus amongst estate planning practitioners is that – while the IRS has never publicly affirmed the use of community property trusts – it is unlikely they will challenge their full step-up in basis treatment. In the event the IRS does subsequently challenge community property trusts and are successful in such challenge what is lost (other than legal fees)? There is no penalty. You simply are back to where you started with a half step-up in basis.
Also, depending on how the community property trust is drafted, there are the potential non-tax benefits of a portion or all of trust becoming irrevocable at the first death to prevent creditors, predators and new spouses (or as I jokingly like to call the pool boy or trophy wife) from taking advantage of a surviving spouse or otherwise having access to the trust assets.
For certain married couples a Tennessee community property trust can provide a potentially high reward with very little drawbacks. However, in determining whether a Tennessee community property trust is right for you several factors should be taken into careful consideration. Each family situation is unique so make sure your estate-planning attorney is familiar with Tennessee’s Community Property Trust Act.