The manner in which title is held by spouses owning real property is significant in many ways and may have significant tax consequences.
California provides many different ways multiple owners of a single property may acquire title. Joint tenancy with right of survivorship and tenancy in common are among the more common ways title is held among multiple owners. Recently, California has allowed for a new manner in which husband and wife may acquire title called “Community Property with right of survivorship.” Holding title in this manner may have significant tax benefits for a husband and wife, when compared to joint tenancy.
Problems with Joint Tenancy. Often times, husband and wife hold title to real property as “husband and wife, as joint tenants.” Assuming husband and wife own property together as joint tenants, this form of title may have some unforeseen and unwanted consequences upon the death of one or both spouses. Generally, upon the death of the first spouse, only one-half of the real property will receive a “stepped-up” tax basis. This is especially important considering the rapid appreciation of real property in today’s market. The surviving spouse may incur a significant amount of capital gains should she decide to sell the property after the death of the deceased spouse/former joint tenant. Of course, if the property is a principal residence and has been occupied 24 out of the previous 60 months, some capital gain may be sheltered from taxes. However, highly appreciated rental properties are not subject to this capital gains exclusion
Community Property with Right of Survivorship. This form of real property ownership was created to allow a surviving spouse to obtain a “stepped up” tax basis for the entire community property asset, while maintaining the survivorship benefit associated with joint tenancy. When husband and wife hold title in this manner, the new tax basis of the property upon the first spouse’s death will be its fair market value on such date of death. Accordingly, should the surviving spouse decide to sell the property shortly after the death of the deceased spouse, capital gains can be minimized or excluded.
Probate Problems
Regardless of whether property is held as community property with right of survivorship, or as joint tenants, another problem may arise after the death of the surviving spouse. Assuming the surviving spouse has not done any estate planning, the property will likely be subject to probate. Probate is a lengthy and expensive procedure whereby the Probate Court oversees the inventory of a decedent’s assets, makes sure creditors are paid, determines who is entitled to the property, and orders distribution of such property. If the surviving spouse had a will, then the property will be distributed to the person(s) designated in the will. Should no will exist, then the court will order the property distributed in the manner set by California law.
Revocable Living Trusts
Generally, through a Revocable Living Trust, a married couple in California may receive the benefit of a “stepped up” tax basis as to their community property upon the death of a spouse, while avoiding probate. When you set up a Revocable Living Trust, you simply transfer all of your property out of your individual names and into your names as Trustees. All property transferred to a Living Trust is outside the jurisdiction of Probate Court.