Chapter 35 - § 35.5 • ESTATE PLANNING CONSIDERATIONS

• Jurisdiction: Colorado

§ 35.5 • ESTATE PLANNING CONSIDERATIONS

§ 35.5.1—Maintaining Community Property Character

It is often important to maintain the community property character of property owned by couples residing in Colorado in order to preserve the step-up in basis upon the death of one of the spouses. This can be accomplished in several ways. One way is by written agreement. As mentioned above, Colorado law allows couples, either before or during marriage, to enter into an agreement with respect to their rights and obligations in any property of either or both of them, whenever and wherever acquired or located, so long as the law of the jurisdiction designated in the agreement has a significant relationship to the agreement. C.R.S. § 14-2-304. Furthermore, the Colorado Uniform Disposition of Community Property Rights at Death Act does not prevent couples from severing or altering their rights in community property. As a result, couples who reside in Colorado can, by agreement, list community property and their intent to either retain its character as community property or to sever it.

§ 35.5.2—Use of Revocable Trusts

A revocable trust can be used as a means of preserving the community property character of imported community property and to prevent commingling of such property with separate property. Such a trust should, ideally, be a joint trust. If separate trusts are established by each spouse and an undivided one-half interest in the community property is transferred to each trust, the result is that each trust owns an undivided one-half interest in the property that is community property owned one-half by each spouse. In other words, each trust would own a one-fourth community property interest in the property. This can be avoided by providing in the trust agreement for the severance of the community property; however, the tax benefit of the step-up in basis would then be lost. The trust should provide that it is governed by the laws of the community property state from which the couple has moved in order to provide more clarity on how the property is to be treated. In addition, care must be taken when drafting a joint trust to avoid inadvertently losing the use of the applicable exclusion amount of the first spouse to die.

Generally, placing community property into a revocable trust for one or both of the spouses will not convert the property into separate property if the trust agreement clearly states that the property is to retain its community property character. Since the character of community property is generally not affected by how title is held (unless the title indicates a different form of ownership, such as with rights of survivorship mentioned above), it would follow that titling property in the name of a revocable trust or trusts should not affect the community property character of the property. Both California and Texas have case law supporting this proposition. See Berniker v. Berniker, 182 P.2d 557 (Cal. 1947); Land v. Marshall, 426 S.W.2d 841 (Tex. 1968). E.g., Estate of Powell v. Powell, 100 Cal. Rptr. 2d 501, 506 (Cal. Ct. App. 2000); Jameson v. Bain, 693 S.W.2d 676, 681 (Tex. App. 1985). The California Family Code specifically addresses the power to revoke a trust that contains community property, confirming that under California law the character of the property does not change when it is transferred to a revocable trust.¹

In addition, the Colorado Uniform Disposition of Community Property Rights at Death Act refers to community property held by a trustee of an inter vivos trust created by the deceased spouse, supporting the conclusion that community property held by a revocable trust does not lose its community property character under Colorado law. C.R.S. §§ 15-20-105 and -106. However, care still must be taken when transferring community property to a revocable trust to avoid a deemed partition of the community property. Both Texas and California law require an express agreement signed by both spouses to partition community property into separate property. Tex. Fam. Code §§ 4.102 and 4.104; Cal. Fam. Code §§ 850 and 852. Furthermore, California statutes expressly provide that an agreement is presumed to exist between the spouses that any community property transferred to a revocable trust retains its character. Cal. Prob. Code...