The Surprising Tax Benefits of Holding Title as Community Property with Right of Survivorship
A married couple in California can hold title to their real property in various forms. Historically, many couples took title in joint tenancy without first consulting with an attorney, merely because their real estate agent would suggest it. However, the way that a couple holds title to an asset can have significant consequences in the event of divorce or the death of a spouse.
Community Property with Right of Survivorship is a relatively new way for married couples to hold title to property in California. Under Section 682.1 of the California Civil Code, property clearly titled “Community Property with Right of Survivorship” and deeded after July 1, 2001 will pass to the surviving spouse upon death of one of the spouses.
Depending on your situation, there may be significant benefits to holding title as Community Property with Right of Survivorship. When title is held in this manner and a spouse dies, their interest in the property is extinguished and it passes to the surviving spouse, avoiding probate. This can benefit the surviving spouse by eliminating any stress associated with probate procedures, family disputes, and attorney’s fees. For more information regarding the probate system and why people choose to avoid it, see our previous post.
Additionally, this form of title allows the surviving spouse to obtain the tax benefits of community property upon the death of the other spouse. Consider the happily married couple, Hank and Wendy, who bought a home in 2004 for $100,000. This is their basis. Now, the house is worth $1,000,000. If Hank and Wendy were to sell the house for $1,000,000, they would be taxed on the difference between the sale price ($1,000,000) and their adjusted basis ($100,000), or $900,000. Now let’s assume that Hank unfortunately dies and Wendy wants to sell the house. In this scenario, the amount of taxable profit will depend on how title is held.
If the parties hold title to the house as Joint Tenants, each spouse owns a 50% interest in the house. When Hank dies, Wendy automatically inherits his half share of the house. The basis of inherited property is adjusted to the value of the property at the date of death. Wendy’s basis will stay the same ($50,000) and the share she inherited from Hank will be adjusted to the value of his share of the property at his death ($500,000). Wendy’s new adjusted basis in the house is $550,000. If Wendy sells for $1,000,000, she is taxed on the difference between the sale price ($1,000,000) and her adjusted basis ($550,000) or $450,000.
However, if the parties hold title to the house as Community Property with Right of Survivorship, each spouse owns the entire property rather than a 50% interest. Upon Hank’s death, both his interest and Wendy’s interest receive a stepped up basis. Thus, the basis of the home is adjusted to the date of death value for the entire property ($1,000,000). If Wendy sells for $1,000,000, she is taxed on the difference between the sale price ($1,000,000) and her adjusted basis ($1,000,000), or nothing.
In the event of a divorce, the house is treated as community property. If you have any questions regarding how your current property is titled or are considering changing your current estate plan, feel free to contact the experienced estate planning attorneys at Lonich Patton Erlich Policastri for further information.
Remember that each individual situation is unique. While this post may detail general legal issues, it is not legal advice. Use of this site does not create an attorney-client relationship.