COMMUNITY PROPERTY OR JOINT TENANCY? THE MARRIED PERSON'S DILEMMA

How a married couple living in a "community property" state holds legal title to their property can be very important. Holding title "the wrong way" could result in a loss of important tax advantages to a surviving spouse.

John and Mary Doe are married and residents of a community property state. A number of years ago they bought a vacant lot and paid $10,000 for it. A year ago they bought some common stock in a local company for $10,000. The tax "basis" of each assets is $10,000. The tax basis of a non-depreciable capital asset is usually its cost. When the asset is sold the difference between the basis and the selling price determines the amount of the profit or loss.

Today, John and Mary's real estate is worth $110,000. The stock is worth $5,000. If they sell the real property and stock for cash, there would be a recognition of capital gain income on the real estate of $100,000 and a capital loss of $5,000 on the stock.

Let's assume that John Doe died on January first of this year. Mary would now like to sell the real estate and the stock. What would be the income tax consequence to Mary?

The tax law provides that the capital assets owned by the deceased get a new tax basis equal to the fair market value at the date of death. The heirs, therefore, need not be concerned about the deceased's tax basis. In effect, the deceased's capital gain is "forgiven" on appreciated assets and any loss is "lost" on an asset which has a market value less than its basis.

Now let's assume that title to the real estate and stock was held by John and Mary as joint tenants. Property held in joint tenancy carries with it the right of survivorship. Therefore, Mary received the real property as the surviving joint tenant with a new tax basis of $60,000 (Mary's original $5,000 basis plus the $55,000 "step-up" adjustment in John's one-half interest) and received the common stock with a new tax basis of $7,500. Note that because at John's death, the stock was worth less than its original $10,000 cost, his one-half interest took a new basis of $2,500, or a "step-down". If Mary sells the real estate, her capital gain recognition is only $50,000. If she sells the stock, she can recognize a capital loss of $2,500.

Now, lets assume that title to the real estate and stock was held by them as community property. Note that joint tenancy ownership between husband and wife is not community property ownership. There must be some separate statement, agreement or law that provides otherwise. For federal income tax purposes, community property ownership gives to the surviving spouse a new basis in both "halves" of the community property. Let us now assume that title to the real estate and stock was held at John's death as community property. The $10,000 original basis in the real property is 'stepped up" to the full $100,000 value. Mary may now sell the real estate and incur no capital gain at all.

Nevertheless, in light of the potentially substantial federal income tax savings, a married couple should hold legal title to appreciated assets as community property and not as joint tenants. Joint tenancy ownership gives to the surviving spouse a "step up" in basis in only the decedent's half of the property.

If the stock has been held as community property at John's death, both halves of the community property would receive a "step down" in basis to $5,000 and, if sold by Mary, there would be no capital loss that she could offset against a capital gain. Therefore, a married couple should consider holding depreciated assets as joint tenants.

Holding title is an important part of your estate plan. Before you change legal title to your real estate or other property, be sure to discuss the possible consequences with your attorney and professional advisors.