Q: I am a California resident, I want my spouse to own 100% of our home when I die, so we've decided to hold it in joint tenancy, as husband and wife. Is that the best way to hold title?
A: No it's not, unless you feel the government deserves more than its entitled to. While Joint Tenancy does have one positive in that it avoids probate court administration after a death to clear title. However, it gives an unnecessary windfall to the IRS because the surviving joint tenant/spouse does not get the "step-up" in his or her tax cost basis to the home. A relatively new way of holding title in California, called Community Property with a right of survivorship * both avoids probate and gives the surviving spouse the full "step-up" in tax basis.
The "step-up" in tax basis means that upon death of the first spouse, the surviving spouse's two ½ interests ( his/her original ½ interest plus the ½ interest they inherit) have their original cost basis increased to the fair market value of the property as of the date of death of the initial decedent spouse or the alternative value date selection for estate tax purposes.
The following examples illustrate why holding title to your home as community property with a right of survivorship can save California residents a lot in taxes over holding title as joint tenants.
Example 1 (joint tenancy): Jane and John Smith are California residents who hold their home as joint tenants. They bought it ten years ago for $400,000. John was the first to die. At the time the fair market value of the house was $1,000,000. Jane inherits John's ½ interest in the house by right of survivorship as the surviving joint tenant. This means that the transfer avoids the lengthy and expensive process of probate.
Jane's ½ interest's tax basis is $200,000 (1/2 of $400,000). Jane inherits John's ½ interest with a 'stepped up" basis of $500,000 (1/2 of $1,000,000). Jane's total tax basis on the home is now $700,000 ($500,000 plus $ 200,000).
Assume Jane has financial problems and is forced to sell the house. She is able to sell the home for the $1,000,000 fair market value. She will pay capital gains taxes on $300,000 (or $1,000,000 FMV minus her $700,000 tax basis).
Now lets look at what happens if the California residents' house was instead held in Community Property with a right of Survivorship.
Example 2 (community property w/ right of survivorship): Assume the above facts except that Jane and John Smith now hold title to the home as Community property with a right of survivorship.
Again assume John is the first to die. Jane inherits John's ½ interest in the home by the right of survivorship as the surviving spouse. This means again that the transfer avoids the lengthy and expensive process of probate. However, Jane now gets a "stepped-up" basis on both her two ½ interests (her original 1/2 interest and John's ½ interest she inherited). Jane's new "stepped-up" basis is now $1,000,000 ($500,000 for her original ½ interest and $500,000 for John's original ½ interest bequeathed to her).**
So now if Jane has financial problems and is forced to sell the home for the $1,000,000 fair market value she will incur Zero federal capital gains taxes because there will be no gain to tax ($1,000,000 FMV minus her $1,000,000 tax basis = 0). **
Clearly holding title as community property with a right of survivorship is more likely a better alternative for John and Jane than Joint Tenancy. Community Property with a right of survivorship accomplishes two goals: one it minimizes capital gains taxes if the surviving spouse should ever need to sell, and two it avoids probate's lengthy process and rather large fees.
This is just an example and there can be other reasons why you might want to hold title differently (e.g. in a living revocable trust, or separate property of one spouse).
The contents of this article cannot be deemed legal advice, nor does it give rise to an attorney-client relationship. The contents of this article are not intended as attorney advertising or as solicitation for legal services.
Always consult a qualified estate planning attorney licensed in your state before making any changes to the way you hold title to your assets.
* Cal. Civ. Code § 682.1
** [Internal Revenue Code § 1014(b)(6)].
*** Note that Jane will also not incur estate taxes because property that one spouse wills or transfers to the other is not subject to estate taxes under an estate tax deduction called the "marital deduction." [ Internal Revenue Code § 2056(a)].
