Dreaming of palm trees but haven’t made the move to Florida? You don’t have to live in the Sunshine State to take advantage of the state’s powerful new estate planning tool, the Community Property Trust, or CPT.
A CPT is a special kind of trust that some married couples can use to save on taxes even if they live in another state. Well-crafted, it can save the surviving spouse substantial capital gains taxes after the first spouse passes away. A CPT is particularly useful if the couple owns assets that have appreciated such as a business, stocks, collectibles, and commercial or residential real estate.
Here’s how it works. Typically, when the first spouse passes away, a new tax value (called a “step up” to today’s fair market value) is assigned to that individual’s half of jointly held assets. The surviving spouse could owe a big capital gains tax bill later if he or she sells assets that were held jointly.
A Florida CPT dramatically changes this calculation. All the assets held in this new trust get a tax basis adjustment (typically, a step up) to the current fair market value when the first spouse dies. As a result, the surviving spouse can then sell the assets, minimizing capital gains taxes.
Imagine, for example, Hal started a business years ago with an initial investment of $10,000. The business grew and is now worth $30 million. Hal’s “tax basis” in the business is a mere $10,000. Then, Hal’s wife dies. Without a CPT, Hal’s tax basis in the business is still $10,000, and if he sells the business for $30 million, he could owe nearly $10 million in taxes on the gain.
On the other hand, if the couple had established a CPT, Hal’s tax basis in the business would jump to $30 million when his wife died. He could then sell the business – or any other assets in the trust – without having to pay capital gains taxes.
If commercial real estate had been rolled into the trust, Hal would be allowed to reset the value of the real estate after his wife’s death. Thus, he would avoid taxes, including depreciation recapture, when selling the property. Hal would be able to sell the real estate, minimize the capital gains tax and eliminate the 3.8% NIIT. Or he could choose to re-depreciate the property.
Don’t try this at home with ChatGPT. Florida’s new trust is a highly technical tool that requires financial and legal savvy. In addition to the step up in basis, there may be other benefits for couples, including protection from some states’ estate taxes.
CPTs are not a new tool. Four other states have offered them for years – without challenge by the IRS. Florida is the latest to join the crowd. While not every couple needs one, it’s a powerful tool worth evaluating.