Posted by Carmen Garcia

Tax Issues for People Living in a Community Property State

Tax Issues for People Living in a Community Property State

Couples living in a community property state own their marital properties, income, and assets jointly. If you earn around $75,000, the income is yours as much as it is your spouse. In the same way, you are obligated by law to repay your spouse's debt even if it does not carry your name. Even a property that has only your name belongs to both of you. 

However, these rules can make matters complicated when filing taxes, especially for married couples filing separately. 


States Designated as the Community Property States 

For the 2021 tax year, nine states are community property states. 

  • New Mexico

  • Nevada

  • Arizona

  • Washington

  • Wisconsin1

  • Louisiana

  • Texas

  • Idaho California

The state of Alaska seems to be in a middle ground. There is a provision to treat one's debts and assets as community properties by signing an agreement in the state. 

From state to state, however, the law has some modifications. As a result, couples need to follow their state rules when dealing with community properties for tax purposes.


Separate and Married Returns 

When couples file other returns, they will have to analyze their income and expenditures to know the portion classified as a marital community. They also need this to know part of their property that belongs to either party separately. In the same way, each spouse earns income equally; they both own community income equally. 

Married filing jointly does come with its downside. Should there be an error or omission on the tax return, Uncle Sam holds both parties liable. This means both of you are guilty of the deliberate mistake or dishonesty of any of the parties.


Community and Separate Income 

In preparing a distinct tax return, the rule of thumb is that half of each community income will be reported on each return. Income that comes from investment gotten before marriage fits this category. Each spouse will claim the community deduction in half alongside their deductions. 

For instance, let's assume you bought a farmhouse many years before marriage. It is your separate property provided you didn't take any step to "comingle" it. An example of such action is making mortgage tax payments using funds gotten after marriage. This money is classified as community money, which cancels out the property's separate property status by including community money.

These rules, however, differ from one state to the other. Should you decide to rent your farmhouse out, the rental income will be classified as community property in Idaho, Texas, Wisconsin, and Louisiana. You won't even have to comingle it. The property might be yours, and you got it before marriage. However, any income from such property will be shared equally between both parties if your tax return is separate, even as a couple.


Community Property Deduction

With the introduction of the TCJA, it doubled the standard deduction in 2018. Since some restrictions on some deductions were to be itemized, many taxpayers discovered that they are above their entire itemized deduction. 

Itemizing in a state with community property makes it a bit tricky to decide who gets a particular deduction related to community assets. Your home might be owned jointly. Either party might not be able to claim mortgage insurance deduction when filing separately. A right call is for each party to claim half of the deduction. 

As long as the social security number for both parties is on Form 1098, which you got from your lender, both parties will be contractually liable for any deductions to be claimed on their tax return.

Filing a separate tax return makes it essential that both parties itemize their deductions. According to the Federal tax law, one spouse cannot itemize, and the other will claim the standard deduction even if they are not staying in a community property state.


In Conclusion: Seek Help

Publication 555 from Uncle Sam has some instructions for couples living in community property states. The IRS also advises that you are better off working with a professional if you want to prepare a separate tax return. 

This makes sense for people with properties that produce income or people nursing the idea of itemizing. With a tax professional like Carmen Garcia, they will weigh both scenarios to determine the best steps for you to take. 



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Carmen Garcia
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