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Changing the Way Married Couples Hold Title in California
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Introduction
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Recent
California legislation has combined the simplicity of joint tenancy with the favorable tax
consequences of community property, by permitting married couples to hold title to
property (including real estate) as “community property with right of
survivorship” – a supercharged form of joint tenancy. This new title retains the
benefit of joint tenancy (elimination of probate upon death of a spouse), while retaining
a key element of California’s community property law (a full step-up in basis in the
property to fair market value). The full basis step-up to fair market value on the date of
decedent’s death (or 180 days thereafter if the alternative valuation method is
elected) eliminates any unrealized gains in the property prior to death.
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A Device for Simple Estates
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Married couples residing in California with simple estate
planning needs should consider this new tenancy. While the revocable living trust is still
a superior estate planning vehicle for larger or more complicated estates, the new
ownership title is preferable to holding assets as joint tenants. Unfortunately, this new
legislation only applies to married couples. Domestic partners or others holding property
as co-owners cannot qualify for community property treatment. If desired, the right of
survivorship can be terminated in like manner to terminating a joint tenancy. California
Civil Code Section 682.1 read as follows: (a) Community property of a husband and wife,
when expressly declared in the transfer document to be community property with right of
survivorship, and which may be accepted in writing on the face of the document by a
statement signed or initialed by the grantees, shall, upon the death of one of the
spouses, pass to the survivor, without administration, pursuant to the terms of the
instrument, subject to the same procedures, as property held in joint tenancy. Prior to
the death of either spouse, the right of survivorship may be terminated pursuant to the
same procedures by which a joint tenancy may be severed. Part I (commencing with Section
5000) of Division 5 of the Probate Code and Chapter 2 (commencing with Section 13540),
Chapter 3 (commencing with Section 13550) and Chapter 3.5 (commencing with Section 13560)
of Part 2 of Division 8 of the Probate Code apply to this property. (b) This section does
not apply to a joint account in a financial institution to which Part 2 (commencing with
Section 5100) of Division 5 of the Probate Code applies. (c) This section shall become
operative on July 1, 2001, and shall apply to instruments created on or after that date.
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Full Basis Step-up
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The full step-up basis in the property as it applies to both
spouses on the death of one, is particularly important. Property held by spouses in joint
tenancy is presumed owned fifty percent by each spouse as separate property and as such
only the decedent’s half receives the stepped-up basis. Under the new legislation,
property held as community property with right of survivorship is fully revalued at the
time of death of one spouse. Only where a marital property agreement has been executed
identifying joint tenancy property as community property, has IRS allowed both halves of
the property to receive the stepped-up basis.
Example Husband and Wife purchased a residence as joint tenants for $100,000 (their
basis in the property for purposes of calculating gain) which is now worth $850,000.
Assume husband dies when the property is worth $850,000.
| Tax Consequences |
Joint Tenancy |
Community Property with Right of Survivorship |
| Husband's basis: |
$425,000 |
$425,000 |
| Wife's basis |
$50,000 |
$425,000 |
| New Basis: |
$475,000 |
$850,000 |
| Sales Proceeds: |
$850,000 |
$850,000 |
| Less Basis: |
($475,000) |
($850,000) |
| Gain: |
$375,000 |
0 |
| Less Residence Exclusion: |
($250,000) |
($250,000)** |
| Taxable Gain: |
$175,000 0 |
0 |
| Tax (28% combined federal and state): |
$35,000 |
0** |
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**Note: the residence exclusion eliminates additional gain
up to $250,000. |
Thus, by holding the residence as community property with right of survivorship, the
surviving spouse will pay no income tax on the sale of the property unless the amount
received exceeds $250,000 over the FMV on the date of death of the first spouse.
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For Tax Purposes, Document Title Controls
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California family law provisions state that
upon dissolution of marriage, real property acquired by the parties is presumed to be
community property regardless of how title is held. For federal tax purposes, IRS looks to
the language on title document (such as a deed or automobile registration) rather than
applying family law principles, to determine tax consequences upon the death of a spouse.
If property was held as joint tenants, then 50% belongs in the estate of the decedent and
the surviving spouse’s 50% share is not entitled to a basis step-up. This can create
a large and unnecessary tax upon a later sale of the property. Unfortunately, a surviving
spouse often has been surprised to learn that although community earnings went into the
purchase of property, the survivor is not entitled to favorable tax treatment under
community property laws because the couple held title as joint tenants. Title, or the
marital property agreement, must clearly state that the property is held as community
property with right of survivorship Civil Code Sec. 682.1 was specifically enacted to
avoid probate and provide a full step-up in the property’s basis upon the death of
one spouse.
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Conclusion
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Consider retitling real property to conform to this new statute. Property
that is held separately will be transmuted into community property if retitled in this
manner, so care should be taken that this conforms to the wishes of the participants. The
only disadvantage to retitling under the new statute would occur where property decreases
in value relative to the cost value of the property and the owners would be entitled to a
loss on the sale. Note: The sale of personal property (a principal residence, vacation
home, personal automobiles) is not entitled to a capital loss deduction, so unless
investment property is involved, there should be no downside to holding title as community
property with right of survivorship.
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| © 1995-2004 Robert L. Sommers, attorney-at-law, all rights reserved. This article and internet site provides information of a general nature for educational purposes only and is not intended to be legal or tax advice. This information has not been updated to reflect subsequent changes in the law, if any. Your particular facts and circumstances, and changes in the law, must be considered when applying U.S. tax law. You should always consult with a competent tax professional licensed in your state with respect to your particular situation. The Tax Prophet® is a registered trademark of Robert L. Sommers.
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