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Tax Advantages

How should a husband and
wife hold to their assets?

Most married couples have taken title to their real estate, stocks and bonds and other appreciating property as joint tenants. Changes in the probate and tax laws require a re-evaluation of this decision.

The advantage of holding title in joint tenancy is to avoid probate upon the death of one spouse. Probate law now provides for the avoidance of probate on community property held by husband and wife.

To avoid probate, the community property must pass to the surviving spouse. There is a beneficial income tax advantage of holding title in community property.

What are the income tax advantages of
holding property as community property?

Property held as community property receives a full “step-up” in basis upon the death of one spouse. Basis is the dollar value put on property you acquire. Your basis in an asset determines the income tax payable upon the asset’s sale. A full step-up in basis means that a surviving spouse pays no income tax on the pre-death appreciation, yet, property held as joint tenants only receives a half step-up in basis upon the death of the first spouse.

The full step-up in basis results in an income tax savings on the sale of an appreciated asset. Property you depreciate for income tax purposes, such as rental properties, receives a new basis for depreciation. This allows the surviving spouse to re-depreciate the property at the higher basis.

How do we take title
as community property?

To take advantage of the income tax benefits, hold title as “John and Mary Smith, husband and wife, as Community Property.” Or you can hold title to your assets as community property in a revocable living trust.

If you want to change title to your real estate into community property, sign a Community Property deed. In California, this does not change your property taxes.

Example of the advantage of community property

· Asset Purchase Price: $20,000
· Date-of-Death Value: $100,000

  • Sale during lifetime of both spouses:
    Taxable gain= Sales price-Purchase price $80,000= 100,000-20,000
  • Sale of Joint Tenancy asset after death of spouse:
    Taxable gain = Sales price – 1/2 Step-up in basis $40,000 = 100,000- 60,000
  • Sale of Community Property asset after death of spouse:
    Taxable gain = Sales price – Step-up in basis $0 = 100,000 – 100,000

The trap of Joint Tenancy:
What is Joint Tenancy?

Joint tenancy is a method whereby two or more individuals hold title to property. Upon death, joint tenancy property automatically passes to the surviving joint tenant(s), without a probate.

Often when two or more related individuals acquire an asset, the asset is placed in joint tenancy without much consideration. If thoroughly considered, joint tenancy would most often be avoided for the reasons listed below.

The problems with Joint Tenancy

For assets such as stocks and bonds, real estate and other appreciating assets, there are income tax disadvantages in joint tenancy. For married persons, the income tax disadvantages are explained on page three. For single persons, a similar loss of a full step-up in basis could result for the surviving joint tenant.

There are several more problems associated with all joint tenancy property. Adding a person as a joint tenant to your property gives them and their creditors-ownership rights over the property. When you sell the property, each joint tenant’s signature is required, and your joint tenants are entitled to part of the sales proceeds.

If your co-joint tenants have creditors or owe the IRS money, the creditors can attach that particular joint tenant’s part of the property.

Additionally, if all joint tenants die together, the assets must be probated. For these reasons, joint tenancy is often called a trap for the uninformed.

A Living Trust provides the advantage of avoiding probate without any of the disadvantages associated with joint tenancy.

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