As previously reported in this Gunster alert, in 2021 Florida adopted the Florida Community Property Trust Act (the “Act”) that enables spouses to create a Florida trust to convert their separate property into Florida community property to take advantage of the income tax benefits afforded to community property at death. Nonetheless, spouses considering setting up a Florida Community Property Trust (a “FLCPT”) need to consider the risks and rewards of FLCPT in relation to their own circumstances.
A FLCPT is a trust created jointly by spouses and funded with their separate property that converts such property to community property. The FLCPT may be revocable or irrevocable. If the trust is revocable, either spouse may revoke the entire trust without the consent of the other spouse at any time. Upon the death of the first spouse, a revocable FLCPT will terminate and the trust’s property will be divided into equal shares and distributed between the surviving spouse and the deceased spouse’s estate. Upon dissolution of marriage, the revocable FLCPT will terminate and the trust’s property will be divided into equal shares between the spouses.
A FLCPT is an “opt in” trust that should not be confused with a joint trust holding pre-existing community property from a community property state. Pre-existing community property from such a state likely has additional or different property rights than community property established under the Act. Thus, for spouses who move to Florida from a community property state, it may not be necessary to terminate a joint revocable trust with pre-existing community property to utilize a FLCPT instead.
A FLCPT provides a substantial income tax planning opportunity for highly appreciated low basis property and a Florida homestead residence that may be sold after the first spouse dies. The main advantage of the FLCPT is that all of the property held in the trust will receive a full basis adjustment to fair market value (generally, a “step up”) upon the first spouse’s death, allowing the surviving spouse and beneficiaries to sell such property after the first spouse’s dies with little to no capital gains tax being imposed.
Nonetheless, this substantial income tax benefit comes with the cost of lost creditor protection on property that otherwise would have been protected if the property instead were held as tenants by the entireties (except for a Florida homestead residence, which has separate Florida constitutional asset protection). Since all property in the FLCPT is treated as community property, a creditor of only one of the spouses would be able to satisfy its claim from both spouses’ shares of the trust property. If the property were not held in a FLCPT and instead were titled as tenants by the entireties, the creditor of only one spouse would not be able to get the property.
Another FLCPT risk is that the IRS may argue that a “double basis step up” (i.e., for both spouses’ shares) is not available for property under an “opt in” community property law like the Act. While the prospect of the IRS not recognizing the FLCPT for purposes of the double basis step up is a concern, it should be mentioned that there is substantial authority to suggest that the IRS should and will respect Florida’s “opt in” Act.
One obvious planning opportunity with a FLCPT is for the spouses’ Florida homestead. The Act specifically preserves Florida homestead asset protection treatment for any homestead transferred to a FLCPT. As stated above, the creditor protection risks associated with community property are substantially reduced by the preservation of homestead asset protection while also allowing spouses to receive a double basis step up. Accordingly, even spouses in high liability exposure professions may want to consider placing their homestead into a FLCPT to receive the double step up in basis with no greater liability risk.
Utilizing a FLCPT to hold a homestead also may be beneficial for spouses with previously created joint trusts containing community property from another state. In that scenario, any Florida residence purchased by the spouses that qualifies as homestead is conclusive evidence that such property is not community property and, therefore, the homestead would not qualify for the double step up in basis if it were held outside a FLCPT. Under such circumstances, the spouses may consider funding a FLCPT with their homestead as its only asset to have the residence qualify for the double step up in basis while still maintaining homestead asset protection.
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This publication is for general information only. It is not legal advice, and legal counsel should be contacted before any action is taken that might be influenced by this publication.
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