Changing the Way Married Couples Hold Title in California

Introduction

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. .

A Device for Simple Estates

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.

Full Basis Step-up

he 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.

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. 

For Tax Purposes, Real Estate Title Controls

alifornia 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.

Conclusion

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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Robert L. Sommers, attorney-at-law. All rights reserved. This 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.