Each spouse has the right to determine who receives all of his or her separate property and one-half of the community property.
Consider the following example: Husband and Wife have a revocable trust.
On Husband’s death, the trust is divided into two trusts: The irrevocable Exemption Trust, which contains Husband’s one-half of the community property and all of his separate property, is available for the benefit of Wife for her lifetime, and then on her death passes to children.
For appreciated property, a step-up in basis can be an important benefit that results in income tax savings when the property is subsequently sold.
(These basis rules will change substantially for deaths in 2010 and later, if estate tax repeal actually goes into effect and is made permanent.) Just as important as the tax ramifications at death is the fact that property characterization determines how and to whom the property is distributed.
(The above mentioned right of reimbursement for a separate property contribution to community property applicable on divorce does not apply on death.
In some situations on death, however, there is tracing of property contributions.) It is necessary to look at how title to the asset is held, the source of funds of purchase, and any property agreement between the spouses characterizing property as separate or community.The property characterization and allocation between trusts can have significant importance.Husband’s Exemption Trust must pass to the children on Wife’s death, but Wife has the right to change the terms of the Survivor’s Trust to leave it on her death to other beneficiaries, such as a new husband.For example, if a couple moves to California, bringing funds earned during marriage by the husband in a separate property state, those funds are the husband’s quasi-community property.In the event of divorce in California, quasi-community property is treated like community property.If Husband and Wife have children of prior marriages, so that the ultimate beneficiaries of the Exemption Trust are Husband’s children and the ultimate beneficiaries of the Survivor’s Trust are Wife’s children, the importance of the property characterization increases, as does the likelihood of dispute about it by the beneficiaries.