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The interest of each spouse in community property receives a stepped-up basis on the death of the first spouse to die ("D").(1) Property owned jointly by spouses who reside in a common law state, however, takes a stepped-up basis on the death of each spouse only as to the deceased spouse's one-half interest in the property.(2) The basis of the one-half interest owned by the surviving spouse ("S") in such property will not be stepped-up at D's death. Can spouses residing in a common law state transfer property into a joint revocable trust and obtain a stepped-up basis as to all or more than one-half of the property on D's death?
The importance of a stepped-up basis at D's death, if it can be achieved, is obvious. Appreciated property sold between D's death and S's death will trigger less capital gains tax as a result of the basis step-up. If the property is depreciable, the stepped-up basis will increase future depreciation deductions.
The joint revocable trust should be designed to meet these objectives apart from the basis step-up:
a. To defer payment of estate tax until the death of S.
b. To make full use of the unified credits of both D and S.
c. To avoid a taxable gift both on creation of the trust and on D's death.
Estate tax deferral. In the typical joint trust, either spouse may revoke the trust while both spouses are living, but this right of revocation lapses at D's death. D is given a testamentary general power of appointment over all of the trust property. The power, which may be restricted to permit appointment only to D's creditors, will cause all of the trust property to be included in D's gross estate under Sec. 2041. At D's death, the trust subdivides into two trusts, one of which ("the Marital Deduction Trust") will qualify for the marital deduction as a QTIP trust, as a general power of appointment trust or as an estate trust.(3) An allocation to the Marital Deduction Trust of a pecuniary amount or a fractional share sufficient to zero-out D's taxable estate will defer the estate tax until the death of S.
Use of unified credits. When the joint trust subdivides at D's death,...