A new Kansas law offering the benefit of community property may allow married couples to significantly reduce future capital gains and depreciation recapture taxes by obtaining a potential “double step-up” in tax basis on appreciated assets. For families who own businesses, farmland, depreciated real estate, or concentrated stock positions, the tax savings could be substantial.
What Happened?
The Kansas Community Property Trust Act, which became effective July 1, 2026, now gives Kansas residents access to a tax planning strategy once available only in nine “community property” states – Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin. A handful of other states, now including Kansas, have also created this benefit for their residents by passing “community property trust” statutes. Under these statutes, you can “opt in” to community property treatment by creating and funding a community property trust.
Community property is property owned together by a married couple, and their community property rights grant married residents of these states the benefit of a “double step-up” in tax basis, where a married couple’s assets get the benefit of eliminating all of the capital gain in their assets when the first spouse passes, and then again at the survivor’s death.
The new law allows Kansas married couples to voluntarily create and fund a Kansas Community Property Trust (KCPT) and “opt in” to this community property treatment for assets held in the trust.
Why It Matters
The principal benefit of having community property is the potential for a full step-up in tax basis when the first spouse dies, which eliminates built-in capital gain and depreciation recapture taxes.
In states that do not recognize community property as a form of ownership among married persons, only half of jointly owned property receives this benefit at the first spouse’s death – a “half step-up,” which only eliminates half of the capital gain in the assets rather than all of it.
The special treatment afforded to community property is thus a significant tax advantage for married persons living in states where property can be community property.
How a Kansas Community Property Trust Works
To create community property, married couples must transfer assets into a Kansas Community Property Trust. A valid KCPT must:
- Declare that the trust is a Kansas Community Property Trust.
- Have a qualified Kansas trustee – an individual who resides in Kansas or a bank or trust company authorized to act as a fiduciary in Kansas. The Kansas trustee must have the power to maintain trust records and prepare or arrange for the preparation of trust tax returns.
- Be signed by both spouses.
- Contain a disclaimer explaining the nature of the trust and a recommendation to seek legal advice before signing.
What We Know About IRS Treatment
Community property trusts are new to Kansas, but they have existed for some time in other states – the first community property trust statute was enacted in Alaska in 1998. There is no published case or ruling regarding the treatment of the tax basis of property inherited through a community property trust.
In its Internal Revenue Manual, the IRS notes the 1944 U.S. Supreme Court case Commissioner v. Harmon, which held that if spouses in common-law property states like Kansas file separate tax returns, they cannot “opt-in” to a community property system to split their income. Spouses reporting income is not the same thing as heirs reporting tax basis; nonetheless, it is unclear whether a court might extend the holding of Harmon to a community property trust to deny the full step-up in tax basis.
It’s likely that many people who created community property trusts since 1998 have passed away, and their heirs reported a full step-up in basis and elimination of capital gain, seemingly without any controversy with the IRS. The IRS could reverse course, as it can on any tax position, but to date it appears the IRS has not challenged whether the assets held in a community property trust receive the full step-up in basis at a spouse’s death.
Other Considerations
Under a KCPT, married couples must commit to a 50/50 characterization of their property. If the couple gets divorced or the trust otherwise is terminated, then the trust property must be distributed 50/50 between each spouse. Each spouse may leave his or her share as the spouse pleases at death.
For persons who or older or perhaps ill, there could be some urgency if one wishes to obtain the tax benefit of a KCPT. Under the tax code, if one gifts their assets to another and receives the assets back on the other person’s death within a year, the step-up in basis in the assets may be denied. For example, if one spouse has 80% of the couple’s assets and together they create a KCPT, and then the other spouse passes within a year and the assets are returned to the spouse who contributed the assets, the step-up in that 80% of the assets may be denied.
Who Should Consider a KCPT?
Married couples with significant appreciated and/or depreciated assets could realize substantial income tax savings by incorporating a KCPT into their estate plan. A review of an existing plan may be particularly worthwhile if you own:
- Appreciated investment portfolios,
- Depreciated commercial real estate,
- Agricultural property,
- Closely held businesses, or
- Other assets with substantial unrealized gains.
To discuss whether a KCPT would be beneficial to you, please contact Justin Whitney, Phil Johnson, or any other member of the Lathrop GPM Private Client Services group.