Community Property Deductions and Non-Deductible Marital Property
Learn About Community Property Tax Deductions Between Spouses
Married couples who choose not to file joint returns must identify their community income and community deductions so they know how much each spouse should report on a separately filed tax return. Most deductions will be split evenly, with each spouse reporting half the total, but some must be allocated separately. Still others deductions can have a mixed allocation.
Splitting Tax Deductions
A distinction is made between assets that are considered legally owned by both spouses as their marital community, referred to as community property, and those that are legally considered to be owned only by one spouse. This is referred to as separate property.
Rules for deductions and reporting income are classified depending on whether the underlying asset is community property or separate property, or whether the income is community income or separate income, in the nine community property states.
Arizona, California, Idaho, Louisiana, New Mexico, Nevada, Texas, Washington, and Wisconsin observe community property law as of 2020. Spouses in Alaska can make a voluntary election to enter into a community property agreement.
A deduction pertaining to investment expenses would be a community deduction if the investment was community property. The deduction would be a separate deduction for the spouse who earned the income if the investment was that spouse's separate asset. The deduction would be allocated in the same proportion if an investment is a mix of community and separate property,
Allocating Personal Exemptions
The Tax Cuts and Jobs Act (TCJA) of 2018 repealed personal exemptions through 2025, but they could potentially come back if Congress does not renew the terms of the TCJA at that time. The exemption was $4,050 in 2017 for each spouse and each of their dependents, so a family of four could subtract $16,200 off their taxable incomes if they filed jointly.
Each spouse would take their own personal exemption if they filed separate returns in 2017, or if the exemptions return in 2026. The couple can decide who takes the personal exemptions for their dependents if they have any.
A personal exemption can't be split. One spouse can take all three dependents, or two, one, or none of their dependents if the couple had three qualifying children.
Dependents can't be split between parents to claim personal exemptions in the years these exemptions are available, or for purposes of claiming other tax breaks. A child can only be claimed on one parent's tax return, but different children could be claimed on each separate return if the parents had two dependents or more.
Standard Deduction vs. Itemized Deductions
Married couples filing separately must both itemize, or they must both take the standard deduction. Generally, it's advisable to take whichever option is most beneficial across both separate returns.
The Deduction for Traditional IRAs
Individual retirement accounts (IRAs) are considered to be a spouse's separate property under federal tax laws. Each spouse will determine their eligibility for a traditional IRA deduction based on earned income calculated without regard to the community property rules. The same goes for determining eligibility for a Roth IRA.
Mortgage Interest and Property Tax Deductions
Tax deductions relating to real estate will be allocated based on whether the property is community property or separate property. The deduction for mortgage interest and property taxes would be split evenly if the home is owned as community property. The spouse who is the owner of the property would take the deductions if the home was owned as separate property.
These are both itemized deductions, so one spouse can't claim them while the other claims the standard deduction if they file separate returns.
Personal Itemized Deductions
Personal expenses such as those for medical expenses, gifts to charity, and college tuition would be deductible for the spouse who actually paid the expense, provided that they're paid from that spouse's separately maintained funds. Again, many of these are itemized deductions, so one spouse couldn't claim them if the other is claiming the standard deduction on a separate return.
Spouses would evenly divide the deduction between themselves if the expense was paid out of community funds, such as a jointly-owned bank account.
The Alimony Deduction
The alimony deduction was also repealed by the TCJA for divorce or separation agreements or decrees entered into after December 31, 2018, or if an older order or agreement was changed after that date.
Outside of those timeframes, alimony was deductible for the spouse making the payment to the extent that the payments exceeded 50% of the spouse's imputed community income if one spouse is paying alimony or separate maintenance to another spouse prior to their divorce being finalized.
It's possible that the alimony deduction will return as well if the TCJA is permitted to expire at the end of 2025. Spouses receiving alimony would also have to claim it as income should the deduction be reinstated.
Each spouse is considered to already own half of the community income, so transfers of those amounts tax neutral. Amounts in excess of the community income allocations are separate income to the receiving spouse and a separate deduction for the paying spouse.
IRS. "Section 1. Basic Principles of Community Property Law." Accessed April 29, 2020.
IRS. "Publication 5307 Tax Reform Basics for Individuals and Families." Pages 1 and 7. Accessed April 29, 2020.
IRS. "Exemptions, Standard Deduction, and Filing Information For Use in Preparing 2017 Returns." Page 11. Accessed April 29, 2020.
IRS. "Dependents 3." Accessed April 29, 2020.
IRS. "Topic No. 501 Should I Itemize?" Accessed April 29, 2020.
IRS. "Publication 555 (03/2020), Community Property." Accessed April 29, 2020.