COMMUNITY PROPERTY VS. JOINT TENANCY
In the few community property states (Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, and Washington), it is generally highly suggested that property titled as joint tenancy be changed to community property in order to provide a full step up in basis upon death. (Please see unique laws for the state of Louisiana.) Basis is defined as the "cost" above which a gain/profit will be determined and thereby taxed. For example, if a home was purchased for $40,000 and subsequently sold for $100,000, there is a $60,000 taxable event.
(New California Law effective July 1,2001) http://members.home.net/lacro6000/CPdeed.html
But should one spouse die, the basis for future gain determination is changed
by IRS rules. In pure joint tenancy states, one half of the deceased's basis
is adjusted upward to the value on the date of death. In the above situation,
assume that the property was worth $100,000 on the date of death. If the
surviving spouse then sold the property, the rules allow one half of the
deceased's original basis of $20,000 (we'll say that each spouse initially
paid half, though there can be different amounts. 1/2 of $40,000 initial
purchase) to be moved upwards to 1/2 of the current value or $50,000 (1/2
of $100,000). The survivor's initial non adjusted basis
($20,000) is added to that yielding a total of $70,000. Therefore if the
property is then sold for $100,000, the basis of $70,000 is subtracted for
a total taxable gain of $30,000. At a 20% tax bracket, the tax equals $6,000
(add your state captial gains tax as necessary) .
Note: Other costs may be added to basis- improvements, additions, etc.
Further, any depreciation will lower basis but since we are discussing a
residential home, that is normally a moot issue (though a business in a home
can cause depreciation).
In the states allowing community property titling, a FULL step up
in basis is allowed. Therefore both halves are moved to a new basis
of $100,000. A sale at $100,000 therefore shows NO gain. So which is better?
A basis of $70,000, a gain of $30,000 and a tax of $6,000+ or a basis of
$100,000, a gain of $0 and a tax of $0? It's almost as simple as that.
There are few issues to consider, however. The first concern is what is necessary to convert joint tenancy to community property? Some attorneys state that a new deed is probably not necessary- just a statement in a will or trust is sufficient. Federal laws supposedly allow a retroactive change to community property after the first to die, but it may be overlooked in the emotional times after death. One should check with an estate planning attorney to determine what is best for them. I will add this cautionary note however. Post mortem (AFTER a death) estate planning is fraught with problems. Do all of your planning beforehand. I absolutely suggest redeeding of the property while both parties are alive. Normally, there are no tax adjustments, appraisals- just a change of title between spouses.
Also of equal importance, it may be possible for those couples moving from
a community property state to a joint tenancy state to maintain the community
property status after such move.
Here is an illustrated example.
Assume $100,000 initial purchase of home (no depreciation or additions) with each spouse "paying" half of the cost. The house is worth $600,000 on date of death when the husband dies.
Joint Tenancy Basis
|1/2 step up in basis equals||$350,000|
Community Property with Full Step Up in Basis
|and property worth||$600,000|
|Full Step up in basis equals||$600,000|
Assume property sold for $600,000. With joint tenancy there is a gain of
$250,000 ($600,000 - $350,000 basis). If we assume just the federal capital
gains tax at 20%, that equals $50,000.
With community property, the basis is $600,000 for NO GAIN. Admittedly one can discuss the new use of up to $500,000 exemption on the sale of a home, etc., but that is post mortem planning and not suggested. Further, let's say that this was a mutual fund instead of a house. Now there are no offsets from tax and the savings are clearly available.
(This refers only to the gain upon sale. Estate taxes are a separate issue
UNLESS THERE ARE OTHER OUTSTANDING REASONS FOR TITLING DIFFERENTLY, COMMUNITY PROPERTY IS AN OPPORTUNITY TO REDUCE TAXES WITHOUT CAUSING ANY PROBLEMS. THERE IS NO REAPPRAISAL OF PROPERTY WHEN IT IS REDEEDED FROM JOINT TENANCY.
But, as with all legal and financial planning issues, please contact someone
with the expertise to review your situation definitively. You may have unique
circumstances where this may not be appropriate (living trusts usually take
care of this internally).
Do NOT check with just any attorney or CPA. Do NOT assume they understand this. Find someone with direct expertise in real estate, estate planning, etc.
Community property: (pdf 2001) Husband bought life insurance on his life using community property (residence in Louisiana). Husband named as owner. Wife died first; on husband's later death estate argued that only one-half of the value of the policies should be included in his estate tax return. The Tax Court agreed with the Estate, finding that there is no evidence to overcome the presumption of community property and therefore only one-half the life insurance proceeds should be included in decedent husbands taxable estate.
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