While joint tenancy is a common method for spouses to hold title to property, in community property states such as California, spouses holding property as joint tenants with right of survivorship (JTWROS) might lose out on a BIG income tax benefit.
Step-up in Tax Basis is Key
When someone passes away, the person inheriting their real property takes the property with a basis equal to the fair market value of the property at the date-of-death (or alternate valuation date). That basis is what is used to figure out whether there is taxable gain or loss when the property is subsequently sold.
For example, if my uncle leaves me real property that he paid $50,000 for but is worth $300,000 at the time of his death, my tax basis is $300,000. If I turn around and sell the property for $300,000, I have zero taxable gain ($300,000 sales price minus $300,000 tax basis). The $250,000 of appreciation in the property goes untaxed.
When the First Spouse Passes Away in a Non-Community Property State
In a non-community property state, when the first spouse to die leaves his or her half of the property to the surviving spouse, the deceased's half of the property receives a step-up in basis, and the surviving spouse's half of the property does not. Here's what that looks like:
H and W purchased their home in 1980 for $100,000, and held title as joint tenants. When H passed away in 2017, the home was worth $500,000. His half of the home, which cost $50,000 and was worth $250,000 at death, passed to W with a step-up in basis to $250,000. W's half of the home retained its original basis of $50,000. If W turned around and sold the house for $500,000, her taxable gain would be $200,000 ($500,000 sales prices minus basis of $250,000 on H's half plus $50,000 on W's half). $200,000 of the total appreciation of $400,000 goes untaxed. Federal income tax bill alone will be at least $30,000.
When the First Spouse Passes Away in a Community Property State
If the property is community property BOTH halves will receive a step-up in basis. This is an enormous benefit available to spouses in community property states. Using the same facts as above but the property is titled as community property, the property would pass to W with a basis of $500,000 and her taxable gain would be ZERO. The full $400,000 of appreciation in the value of the home goes untaxed, and she would not owe any taxes at the time of sale, compared to owing $30,000 in a non-community property state!
In a Community Property State, You'll Lose the Benefit if You Hold Title as Joint Tenants
So if you live in a community property state (Alaska, Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington and Wisconsin) go find the deed to your real property. If you hold title as joint tenants, or JTWROS, or tenants-in-common, find a real estate, tax, or estate planning attorney to transfer title to community property with right of survivorship, or better yet, include the property in a revocable living trust as community property. Take advantage of this BIG income tax benefit and save your family from unnecessary taxes!
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