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Foreclosure ATG - Chapter 8 - Community and Common Law Property

Publication Date - February 2015

NOTE: This guide is current through the publication date. Since changes may have occurred after the publication date that would affect the accuracy of this document, no guarantees are made concerning the technical accuracy after the publication date.

Community and Common Law Property Systems

Only an overview of community and common law property rules are presented due to the complex issues that could arise. For complete procedural guidance refer to IRM 25.18, Community Property, and Publication 555 for additional information on married taxpayers domiciled in common law and community property states.

Consideration of the ownership of foreclosed property may have different tax consequences for taxpayers who own separate property from their spouses. The state where the taxpayers live may have an impact on how a foreclosure is reported. Federal tax is assessed and collected based upon a taxpayer's interest in property and state law. Thus, the effect on each spouse should be addressed and case file documentation should include property considerations. 

Whether property is characterized as community property becomes less important if a joint filing election is made. Spouses filing a federal joint return are jointly and severally liable for the tax on all income of both spouses reportable on the joint tax return, whether it is community property or separate property.

Forty-one states have adopted common law property systems. Common law treats each spouse as a separate individual with separate legal and property rights. Generally, each spouse owns and is taxed on the income that is separately earned.

Nine states have adopted the community property system. These states are Arizona, California, Idaho, Louisiana, New Mexico, Nevada, Texas, Washington and Wisconsin. Alaska has also adopted a community property system, but it is optional. The U.S. Territory of Puerto Rico is also a community property jurisdiction. Community property is where each spouse contributes labor for the benefit of the family and shares equally in the profits and income earned by the family. Thus, each spouse owns an automatic fifty percent interest in all community property, regardless of which spouse acquired the community property. 

Community Property

Generally, community property is property that the taxpayer, taxpayer's spouse or both spouses together acquire during their marriage while the taxpayer and taxpayer's spouse are domiciled in a community property state, property agreed upon to convert from separate to community property, and property that cannot be identified as separate property. Refer to Publication 555, Table 1 for more information.

Spouses are also considered to share debts. Each community property state has its own specific property laws. Depending on state law, creditors of spouses may be able to obtain all or part of the community property, regardless of how it is titled, to satisfy debts incurred by either spouse. State laws vary greatly on what property can be reached.

In Aquilino v. United States, 363 U.S. 509 (1960) and Morgan v. Commissioner, 309 U.S. 78 (1940), the court decided that Federal law determines how property is taxed, but state law determines whether, and to what extent, a taxpayer has "property" or "rights to property" subject to taxation. Accordingly, federal tax is assessed and collected based upon a taxpayer's state created rights and interest in property.

IRM, Tax Assessment and Collection under Community Property Laws, states that, for income tax purposes, if spouses file separate returns, each spouse is taxed on 50% of the total community property income regardless of which spouse acquired the income. Poe v. Seaborn, 282 U.S. 101 (1930). In addition, each spouse is taxed upon 100% of his or her separate property income. Community property may also affect basis in property.

Refer to IRM Exhibit 25.18.1-1, Comparison of State Law Differences in Community Property States, for a summary of the differences in the community property laws adopted in the nine community property states. 

Generally, separate property is:

  • Property that the taxpayer or taxpayer spouse owned separately before their marriage.
  • Money earned while domiciled in a non-community property state.
  • Property that the taxpayer or spouse received separately as a gift or inheritance during their marriage.
  • Property that the taxpayer or spouse bought with separate funds, or acquired in exchange for separate property, during their marriage.
  • Property that the taxpayer and spouse converted from community property to separate property through an agreement valid under state law.
  • The part of property bought with separate funds, if part was bought with community funds and part with separate funds.


Dividends, interest, and rents from community property are community income and must be evenly split.  Income from separate property is separate income in Arizona, California, Nevada, New Mexico, and Washington. Idaho, Louisiana, Wisconsin, and Texas characterize income from separate property as community income.


When married taxpayers file separate returns, deductions generally depend on whether the expenses involve community or separate property. Refer to Publication 555, section entitled Community Property Laws are Disregarded for more information.

Gains and losses

Gains and losses are classified as separate or community property depending on how the property is held. For example, a loss on property, such as rental property held separately, is a separate loss. On the other hand, a loss on property, such as a casualty loss on a home held as community property, is a community property loss. See Publication 544, Sales and Other Dispositions of Assets, for information on gains and losses.

Example 35. Henry and Mabel are married and filed separate tax returns. They live in a community property state that treats income from separate property as community income.  Their income during the year is summarized in the following table as follows:

Community Property Income

Income Description








Consulting business








Rent from community property




Dividends from separate property




Total community property income




Considering the facts in this example, Henry would report $55,000 (110,000 divided by 2) and Mabel would report $55,000 ($110,000 divided by 2), on their separate tax returns. However, Henry would report self-employment tax on the entire $5,000 from his consulting business. Note that there are exceptions in all states that treat some items of income as separate property. Refer to IRM 25.18 and Counsel for additional guidance.

Example 36. Fred and Robin are married and live in a home that they purchased together. Fred owns a second home that he purchased prior to marriage. They fell on hard times and Fred became delinquent on the mortgage of his second home. Because of nonpayment, the bank notified him that it would foreclose on the home. A month later, the lender approved his loan modification under one of the Making Home Affordable programs and canceled a portion of the mortgage loan (recourse debt). The taxpayers filed separately. SP means separate property in the following information.

First, determine whether Fred can exclude cancellation of debt income under the insolvency exclusion. Secondly, determine whether Fred can exclude cancellation of debt income under the qualified principal residence indebtedness exclusion. Fred's canceled mortgage debt $75,000.

Additional facts include Liabilities and Assets immediately before the discharge of debt:

  • Jointly owned liabilities $250,000
  • FMV of jointly owned assets $525,000
  • Fred's mortgage (SP) $200,000
  • FMV of Fred's home & assets (SP) $155,000

CP = Community Property; SP = Separate Property

Insolvency Calculation
Assets and Liabilities




Liabilities (CP)




Fred's mortgage (SP)




Total Liabilities








Assets (CP)




Fred's assets (SP)




Total Assets












In summary, Fred was solvent by $92,500 ($325,000 total liabilities minus $417,500 total assets). Robin was solvent by $137,500 ($125,000 total liabilities minus $262,500 total assets).

Because Fred purchased the second home prior to marriage, his property is treated as separate property. Since Fred is solvent, he would report the entire $75,000 of the canceled debt as other income on his tax return. Robin is not required to report any of the canceled debt in her income.

Fred cannot exclude the $75,000 under the qualified principal residence indebtedness exclusion, as the cancelled debt was debt related to his second home and not his principal residence. Fred does not qualify for any other exclusion.

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Page Last Reviewed or Updated: 16-Aug-2016