Understanding the Testamentary Effects of Community Property Rules
Significant migration to Florida has caused community property rules to have an important place in Florida jurisprudence. In 1992, the Florida probate statutes were amended to add a version of the Uniform Disposition of Community Property Rights at Death Act (F.S. §§732.216 through. 228) (the “act”). The purpose of this article is to examine various provisions of the act and to look at other community property rules that could have an effect at the death of a Florida resident. In the end, it appears that the act accomplishes less than one might have expected, but it does serve an important purpose by raising the community property issue. There is case law in Florida that developed independently of the act that furnishes protection to a surviving spouse regarding an interest in community property, and there are areas that a practitioner should be aware of where state law on community property and federal law may intersect.
At the start, it is important to identify the states that maintain varying sets of rules based on community property considerations. They include two of the largest states in the country. They are California, Texas, Louisiana, Arizona, Washington, Idaho, Wisconsin (“marital property” in Wisconsin is quite similar to community property), New Mexico, Nevada, and Alaska. Puerto Rico is also included. In addition to these, one should assume, at least initially, that each civil law country is also a community property-like jurisdiction.1
According to the prefatory note to the drafters’ discussion of the uniform act, the purpose of the rules is to “preserve the rights of each spouse in property which was community property prior to change of domicile, as well as in property substituted therefor where the spouses have not indicated an intention to sever or alter their ‘community rights.’”2
The presumption behind the act is that married persons from community property jurisdictions intend to retain the community property traits of their previously acquired properties when they take up residence in a common law state unless they explicitly disavow that intention. While not set forth explicitly in the original legislation (the Uniform Disposition of Community Property Rights at Death Act, drafted in 1971 under the guidance of the National Conference of Commissioners of Uniform State Laws), the rationale for the presumption is likely to be that the community property rules encompass a degree of fairness that is greater than that offered in a common law state. And this is sensible, since the “fairness” is that one of the spouses has an interest in an asset that he or she might otherwise lose unknowingly if common law rules alone are applied to determine ownership in a common law state.
The act covers personal property, wherever located, if it: 1) was acquired as, or became and remained, community property under the laws of another jurisdiction; 2) was acquired with rents, issues, or income of, or the proceeds from, or in exchange for, community property; or 3) is traceable to that community property.3 Once you have personal property that is classified as community property, any other personal property that is traceable to it is deemed to be community property under the act. Therefore, if a couple leaving a community property state sells all of its personal property and acquires new personal property in Florida, all of the newly acquired personal property will be community property under the act. In Florida’s enactment of the act, the rule for real property is similar, except that the real estate must be located in Florida for the rule to apply. This is because rights in real estate are generally determined under the law of the state in which it is located. Prior to 2003, the act excluded from its applicability both homestead and real estate held as tenants by the entirety. However, the act was amended in 2003 to strike the exception of homestead from the act’s application. Before the change, the surviving spouse would have been dependent solely on the Florida Constitution for homestead protection, meaning that he or she could have been left with a life estate in the residence if the decedent was also survived by minor children or if the decedent died intestate survived by lineal descendants. However, with the change to §732.218, the surviving spouse can obtain title to his or her half of the homestead, and can also obtain no less than a life estate in the decedent’s half, assuming that the homestead disposition rules and restrictions continue to apply to the decedent’s one-half interest. (Section 732.225, part of the original act, was not amended in 2003 when homestead was made subject to the act. It states that the “reinvestment of any property to which [the act applies] in real property located in this state which is or becomes homestead property creates a conclusive presumption that the spouses have agreed to terminate the community property attribute of the property reinvested.” This is now just plain wrong and must be dealt with by the legislature).
The act specifically excludes real estate held by a couple as tenants by the entirety but does not include a similar exclusion for personal property, meaning, presumably, that heirs or devisees of a deceased spouse (other than the surviving spouse) may claim an interest in assets that otherwise appear to be the surviving spouse’s alone because they had been owned by husband and wife.
F.S. §732.218 sets forth rebuttable presumptions that apply to determine whether property is community property subject to the act:
1) If property was acquired by a spouse during marriage while domiciled in a community property jurisdiction, that property is presumed to have been acquired as, or to have become and remained, property to which the act applies.
2) If real property in Florida and personal property wherever located were acquired by a spouse during marriage while domiciled in a common law jurisdiction and title to that property was taken in a form which created rights of survivorship, it is presumed to be property to which the act does not apply.
Upon the death of a married person, one-half of the property subject to the act is the property of the surviving spouse, and that half is not subject to testamentary disposition by the decedent or to distribution after the first deceased spouse’s death under the laws of succession. The half of property that is subject to testamentary disposition or distribution under the laws of succession is not included in the decedent’s elective estate.4
Through operation of the act, an interest in property titled in the name of the surviving spouse alone may be subject to transfer to the decedent’s beneficiaries or heirs other than the surviving spouse. Conversely, one half of property that the decedent intended for other beneficiaries or for transfer in trust for the surviving spouse may, in fact, belong to the surviving spouse and not be subject to disposition by the decedent.
For property titled in the name of a surviving spouse, F.S. §732.221 provides that the personal representative or a beneficiary of the decedent may institute an action to perfect title to property to which the act applies. But the personal representative has no duty to discover whether any property held by the surviving spouse is property subject to the act unless a written demand is made by a beneficiary within three months after service of a copy of the notice of administration or by a creditor within three months after the first publication of the notice to creditors.
Section 732.221 appears to be designed to protect a personal representative and not the beneficiaries of the decedent’s estate. Under normal precepts of a personal representative’s fiduciary duties, it would be logical for a beneficiary to assume that the personal representative’s duties would include a determination of property potentially subject to the act that is in the hands of the surviving spouse. In fact, in many circumstances, it is probable that the personal representative will either have more information or have access to more information about the decedent than most beneficiaries. Also, in general, the personal representative owes sufficient duties either directly or indirectly to the beneficiaries that they could be excused for thinking that the personal representative is working for them. However, if a community property issue in the administration of the estate is overlooked, it will be the attorney hired by a beneficiary to protect his or her interest, and not the personal representative or the personal representative’s attorney, who will be on the spot.
Section 732.223 is the mirror of §732.221. If property covered by the act was titled to the decedent at death, title to the surviving spouse’s share may be perfected by an order of the probate court or by execution of an instrument by the personal representative or the beneficiaries of the estate with the probate court’s approval. As under §732.221, the personal representative has no duty to inquire, but only to react properly if a claim is brought to the personal representative’s attention by the surviving spouse or his or her successor in interest within three months of service of the notice of administration.
There is a lack of clarity in the act regarding the three-month period in which to bring a claim. The three-month limitation seems clearly to apply to the personal representative who is directed to act by a beneficiary. However, the act does not appear explicitly to time bar an independent action under §732.l221 to determine community property rights brought by the beneficiary or by the surviving spouse on his or her own. It therefore appears that a spouse or a beneficiary can initiate an action to perfect title to subject assets after the expiration of the three-month period, but for how long after the expiration is not clear. The completion of estate administration would end any effort to assert community property rights in the probate venue; however, a body of case law on the subject, discussed below, suggests that the spouse or beneficiary who “sits on his hands” during the estate administration is not completely out of luck.
Section 732.222 provides security to a purchaser or lender for value with respect to property governed by the act. Neither has to make any investigation to determine whether the act applies to the property in question. The key to obtaining protection under this section is that value have been given by the purchaser or lender. Similarly, the act states that it does not affect rights of creditors with respect to covered property.
The act does not create rights in property. In the language of the act, it allows one to “perfect title” to an asset. Implicitly, the person not availing himself or herself of the act’s benefits retains “unperfected title” and can resort to other legal alternatives to gain legal title to what is equitably his or hers. Florida case law, discussed below, provides legal relief that does not rely on the act. While the act has limitations, it serves the very useful purpose of reminding the practitioner that community property rules may have an impact on a couple’s planning and in the administration of the estate of the first spouse to die.
Case Law in Florida
There is Florida case law on the application of community property rules to Florida testamentary transfers. In Quintana v. Ordono, 195 So. 2d 577 (Fla. 3d DCA 1967), aff’d, 202 So. 2d 178, decided before the adoption of the act, the court analyzed the application of community property rules in this state. In Quintana, the decedent held title to personal property acquired during his marriage while he was working in Florida but was domiciled in Cuba. The decedent had willed the property to his children and his wife sued for a portion. The court examined the law of Cuba, determined that neither spouse had any separate property that he or she brought into their marriage, and concluded that the subject property was community property so that one-half of it was the wife’s property. The couple’s change of domicile from Cuba to Florida after the property had been acquired did not affect this conclusion. The children had also argued that if the wife had a claim to the property, she had lost it by failing to file a timely claim in the probate of the decedent’s estate. The court concluded that the beneficiary of a trust (here, a resulting trust) is not subject to the nonclaim statute. An unanswered question is how long a spouse has to assert a claim to a community interest in an asset? When, if ever, does laches come into play?
The Quintana holding was favorably cited in a case involving the divorce of former Cuban domiciliaries, Camara v. de la Camara, 330 So. 2d Fla. 818 (Fla. 3d DCA 1976), and in a case to determine the extent to which the law of Puerto Rico, where the parties lived when they entered into a prenuptial agreement, should govern in a probate proceeding in Florida, where the parties were residing at the husband’s death, Estate of Santos v. Nicole-Sauri, 648 So. 2d 277 (Fla. 4th DCA 1995). Neither of the later cases mentions the act.
The Quintana case has become settled authority for the analysis that ought to be undertaken when examining the effects in Florida of community property rules. In assessing Quintana, it seems clear that the analysis and holding retain their full effect without any recourse to the provisions in the act. Recourse to the act would have enabled the spouse to avoid the litigation, certainly a worthwhile result, but the conclusion would have been the same. For the surviving spouse or beneficiary who neglects to perfect title under the act, the Quintana holding remains a possible source of legal victory.
Other Applicable Rules
How do community property rules affect planning that involves federal law issues? For example, ERISA frequently trumps state law. In Boggs v. Boggs, 520 U.S. 833 (1997), the U.S. Supreme Court ruled that ERISA preempts local community property law, with the result that beneficiary designations of ERISA plans are free from interference from contrary community property law rules. In Boggs, the decedent’s second wife received a survivor’s annuity from her husband’s interest in a qualified plan. The children of decedent and his first wife argued that they had received an interest in the plan account through their mother’s will because she had a community interest in the plan under Louisiana law. The Court, in a 5-4 decision, held that the children’s rights derived from community property law effects could not interfere with the surviving spouse’s rights that received protection under ERISA.
In Bunney v. Commissioner, 114 T.C. 259 (2000), the U.S. Tax Court examined the effect of community property law on IRA distributions. The court acknowledged that all contributions to the husband’s IRA had been made with community funds. In connection with the couple’s divorce, husband took a large distribution from his IRA to acquire wife’s interest in their residence. The question analyzed by the court was whether wife, as owner of one-half of the contributions, should be taxable on one-half of the distribution.
Section 408 of the Code governs IRAs. Subsection (g) states simply that §408 is to be applied without regard to any community property laws. The court, in holding that no part of the distribution would be taxable to wife, concluded that applying community property law principles would conflict with the definition of an IRA as being created “for the exclusive benefit of an individual or his beneficiaries.” (§408(a)). It would also jeopardize the participant’s ability to roll over the IRA funds into a new IRA and would affect the application of the minimum distribution rules, according to the Court. While concluding that the account holder was the sole distributee, the Court, in a footnote, said that it was not addressing whether §408(g) preempts community property interests in IRAs altogether.
Life insurance policies and proceeds are affected by community property considerations. If a policy has a community property connection, it will be necessary to examine the local law in the particular community jurisdiction in order to be on sure footing regarding the estate or gift tax consequences at the death of the insured or the noninsured spouse. There are two different theories for attributing ownership of insurance policies between spouses, the apportionment theory and the inception of title theory. Under the former, ownership of a policy depends on the source of funds used to pay the premiums over the life of the policy. Under the latter, ownership is based on the source of funds at the time the policy was acquired. After that date, if a different source of funds is used to pay premiums, a debtor-creditor relationship is created between the spouses regarding the subsequent premiums.
If clients have a community connection to their life insurance, the results can be very different than what one is accustomed to in a noncommunity property setting. For example, the death of the noninsured spouse who is not designated as the policy owner may require that one-half of the value of the policy be included in his or her gross estate for federal estate tax purposes under §2033. And the right to one-half of the proceeds at the later death of the insured could be determined under the testamentary instrument of the first-to-die unless there is evidence that he or she intended to transfer his or her interest in the policy to the surviving spouse. If the proceeds are payable at the death of the insured to a third party, the surviving spouse could be deemed to have made a gift at that time to the beneficiary of one-half of the proceeds.
There are references to community property rules involving life insurance in the estate tax regulations at §20.2042-1(c)(5) and §20.2042-1(b) and in the gift tax regulations at §25.2511-1(h)(9). These regulations make the point that the federal law effects are dependent on the property rights of the taxpayers under state law.
Life insurance that qualifies as community property can be an accident waiting to happen. Consider, for example, your client’s surprise upon learning that one-half of the proceeds of a policy are to be distributed under the will of the non-insured spouse who predeceased the insured (this assumes that the noninsured spouse did not validly consent to the insured spouse’s designation of a beneficiary as to the noninsured’s ownership interest in the policy). How do you explain that to the “ex”-beneficiaries? When preparing an irrevocable life insurance trust for a client, make certain that the policy is free from community property traits. Have the noninsured spouse take whatever steps are required to release all of his or her rights in the policy. If the apportionment theory applies, have the insured spouse transfer sufficient separate funds to repay the spouse for his or her share of community funds used to pay premiums. Under the inception of title theory, determine who obtained an ownership interest at the time of purchase, the source or sources of premium payments and thus the total required to acquire the interest of the noninsured spouse. Trying to accomplish these tasks without the help of counsel in the community property jurisdiction seems like a very difficult task. The spouses may also consider entering into a postmarital agreement whereby the noninsured spouse agrees to release his or her community property rights in the policy. This is not a step to be taken lightly, and it necessarily requires the couple’s attorney to carefully consider what could be a conflict of interest between the attorney’s clients.
Two of the most common objectives associated with estate planning in a common law jurisdiction are to split the estates of spouses so that each makes use of the applicable exclusion amount, and to achieve a step-up in basis for estate assets to the fullest extent possible. Community property assets achieve both of these, and so a practitioner should think twice before recommending a change in the titling of assets that removes the community property benefits. For example, the customary advice to clients to divide their assets so that each has assets to fund a credit shelter trust could be the wrong advice. If the subject assets are community property, the division into separate property results in the loss of stepped-up basis for those owned by the surviving spouse.
When one spouse is not a U.S. citizen, intra-spousal gifts to that spouse may not exceed $114,000 in value per year. Therefore, if the best strategy is to split the estates, this limitation could make that task more difficult than usual. To the extent the spouses have community property assets, the splitting has already been accomplished, and so, as to those assets, the limitation on annual gift-giving to a noncitizen spouse is not applicable.
If, at the death of the first-to-die, his or her share of community property is included in the gross estate, the half held by the survivor also receives the same basis adjustment as the half owned by the decedent. This rule is to be contrasted with the general rule in common law states where only the basis of the decedent’s half of jointly owned property is adjusted. This free step-up (assuming assets have appreciated since being acquired) is a great benefit that cannot be overlooked when planning for a couple.
The act makes clear that migrating couples bring their community property accoutrements with them when they arrive here, whether or not they know it. It is thus important for the practitioner to highlight this issue for clients and to take the steps necessary to continue or to end the community in affected assets.
The community property issue presents itself not only when couple arrives from one of the affected states, but also when arriving from a civil law country. There are increasing numbers of immigrants from South America, and estate planning for these persons must take into consideration the laws of their former domiciles in deciding now on how property should be titled and how estate planning documents should be prepared.
1 Community property-like jurisdictions include, for example, Spain, France, Germany, Venezuela, Colombia, and Brazil.
2 Prefatory Note, Uniform Disposition of Community Property Rights at Death Act.
4 Fla. Stat. §732.2045(l)(f).
Terrance J. Mullin is a shareholder in Brodsky & Mullin, P.A., in Miami. He practices in the area of wills and trusts, tax and real estate law. He graduated from the University of Texas School of Law, Yale University, and the University of Cambridge.
This column is submitted on behalf of the Real Property, Probate and Trust Law Section, Laird A. Lile, chair, and William P. Sklar and Richard R. Gans, editors.