When a
husband and wife hunt for a home, they consider factors such as the
neighborhood, the quality of the school district, curb appeal, or the condition
of the house. However, they frequently overlook something else that is perhaps
just as important: how they take title to their new home. It’s a fact that most married couples
choose joint tenancy. However, joint tenancy will create future tax liabilities
if one of the spouse dies and the property is sold. A married couple can escape
this tax liability by simply taking title as community property (CP) or
community property with right of survivorship (CPWROS). The only time the IRS
will forgive you for the capital gains on your home is if you vested title as
CP or CPWROS. So you should take advantage of it!
In
California, most married couples will hold title to their homes in joint
tenancy because they don’t seek legal counsel, they are not
well informed, or because someone told them that holding title in joint tenancy
escapes probate. However, holding title in joint tenancy escapes probate only
after the first spouse’s death and creates tax liabilities
if the property is sold before by the surviving spouse. And, when the surviving
spouse dies, a probate will become necessary.
How is it
that joint tenancy creates future unnecessary tax liability? Look at an
example. John and Jane, a married couple, bought a home in California for
$100,000 in 1980 and in 2015 it is worth $ 1 million dollars. John dies in 2015.
Jane sells the property for $1 million dollars following his death (also in
2015). What is Jane’s cost basis in computing how much
income tax she will owe? The couple originally bought their home for $100,000
and Jane is still alive; therefore, her cost basis is $50,000 or half of the
original price. When John dies, Jane receives John’s 50% share of the house AND John’s stepped up cost basis as well.
Because Jane is receiving John’s 50% after his death, she is
receiving John’s stepped up cost basis, which includes half of all the appreciation
in the value of the house. When John died, the house was worth $1 million
dollars; therefore, John’s 50% cost basis would be stepped
up to $500,000. When Jane sells the property for $1 million dollars minus her
cost basis of $50,000 and John’s stepped up basis of $500,000, her
taxable proceeds would now be $450,000 ($1,000,000 minus $50,000 minus $500,000
= $450,000). The bottom line here is that in joint tenancy, there is ONLY a 50%
or half stepped up in cost basis, whereas
if John and Jane held title of their home as CP or CPWROS, then the stepped up
tax basis would be 100% and Jane will have to pay ZERO in taxes!
Holding
title as CP or CPWROS is a good method for paying NO income tax for your
surviving spouse in the future? Lets look at the same example. Instead of
taking title in joint tenancy to their home, they took title as CP or CPWROS.
When John dies the house is worth $1 million dollars. Jane sells the house for
$1 million. How much tax does Jane now need to pay? The answer is ZERO tax
liability! Why? Because, when Jane sells the house for $1 million dollars, her
cost basis is also $1 million dollars. This is because Jane received a 100% or
full stepped up cost basis since the home was vested as CP or CPWROS and not
held in joint tenancy.
Therefore,
a husband and wife should strongly consider holding title to their home as CP
or CPWROS because after the death of the first spouse, the surviving spouse can
sell the house and not pay any taxes on the appreciated value of the home.