Why does the trust reference California law when I live in a different state?

I don't live in California, I reside in a common law state, not a community property state. However, my trust says "construction, interpretation and administration of this trust shall be governed by the laws of California" and "all property transferred to this trust will be community property as defined by California law." Is this trust still valid in my state?

Yes, it is fine to use California law to govern your trust when you reside in a different state. This is known as the choice of law provision and is frequently used by attorneys in various scenarios. The principle is similar to the legal ability to form a Delaware corporation regardless of where you live and whether or not you intend to do any business in Delaware. Another example is signing a contract governed by the law of a state other than in which you live.

The validity of this trust for real property shall be governed by the law of the state of its situs. The construction, interpretation and administration of this trust shall be governed by the laws of the state of California regardless of its situs or the domical of the Trustee with regard to all other matters. This choice of law provision is based in part on the legal authority stated in the Restatement Second of Conflict of Laws section 268 (1). This choice of law provision is intended to be exclusive. Restatement Second of Conflict of Laws section 268(1) states,

“As with testamentary trusts, a Settlor may designate which state’s local law will govern construction of the terms of the trust regardless of whether or not the designated state has any connection with the trust.”

If there were a legal dispute arising before the courts, the courts would look to your state’s law to determine validity and to California to determine how the terms of the trust are to be interpreted.

In truth there are only two states that have requirements regarding validity of a trust that are different from California or the other 47 states. Those states are Florida and Louisiana. They require that a trust be witnessed by two witnesses in addition to being notarized. The kit provides this requirement for residents of those states. There is no reason to say the trust at issue is not valid.

Now that we've established that the trust is valid and that California law governs your trust, we turn to why all property transferred to trust becomes community property. By changing the character to community property, your real estate can get the double step up in basis. When the first spouse dies, the real estate gets stepped up for capital gains purposes to the date of death value and when the second spouse dies the capital gains basis gets stepped up again to the date of death value of the second spouse.

By contrast, holding real property with your spouse as joint tenants means you only get a step up in basis on half of the property on the death of the first spouse.