Q. My husband and I hold title to our home in joint tenancy. When we bought it years ago we were told that was the simplest way to avoid probate. However, I now hear that there may be tax advantages to holding title as community property. If so, is there a way to get the tax benefits of community property while still avoiding probate?
A. Yes. Since 2001, a married couple may hold title to California real property as Community Property With Right of Survivorship (“CP-WROS”). Like joint tenancy, upon the first death the property passes to the survivor without probate. However, it comes with an important bonus: the survivor also enjoys the more favorable tax treatment afforded Community Property (“CP”). Now, married couples who hold title as CP-WROS can get the best of both worlds, i.e. probate avoidance plus the favorable tax treatment given to CP.
The CP Tax Benefit Explained: If a married couple holds title as CP or CP-WROS, upon the death of one spouse all of the taxable appreciation between the date of the couple’s original purchase to the date of the first spouse’s death is wiped clean and the property is given a “fresh start.” Its appreciated value on the date of death is deemed, for tax purposes, to be equivalent to its cost for purposes of computing taxable gain on a later sale. This fresh start is called an adjusted basis. In a JT situation, only the decedent’s one-half (1/2) receives this benefit. This difference can mean dramatic tax savings for the survivor. Here is an example of how this works:
Example: The Browns bought their home years ago for $100,000. Assume Mr. Brown dies when it is worth $800,000, that the home continues to appreciate in value, and that Mrs. Brown sells it 2 years later for net sale proceeds of $900,000. If the couple held title as CP or CP-WROS, Mrs. Brown’s capital gain would only be $100,000 ($900K – $800K). By contrast, if the couple held it as JT, her capital gain would be $450,000 ($900K – ($50K as H’w 1/2 + $400K as W’s 1/2). Of course, in both situations, since the property was their home, she would likely be able to shelter up to $250,000 in gain under the “sale of principal residence rule,” but in the JT situation $200,000 ($450K — $250K) would still be exposed to capital gain tax. By contrast, if the home were held as CP or CP-WROS, the $250K “sale of principal residence” exclusion would more than shelter all of the more modest $100K in capital gain ($900K — $800K) and she would incur no tax at all.
The JT form of title would thereby cost her tens of thousands of dollars in capital gain tax that she might have otherwise avoided. Moreover, if the property were not her principal residence but were, instead, a vacation home or rental property the tax benefit in holding title in one of the CP forms would be even more dramatic, because the opportunity to shelter up to $250K in gain under the “sale of a principal residence” rule would not be available.
Note: While the IRS has not yet issued a definitive statement that CP-WROS will qualify for this basis adjustment upon the death of the first spouse, a few other states have similar laws and the IRS appears not to have challenged this treatment.
Of course, another technique for both avoiding probate and securing the tax benefits of CP title is to create a Living Trust with recitals in the trust (or in the funding deeds) that real property placed into the trust is deemed to be “community property”, and many couples wisely choose this option. But for those couples without a Living Trust who desire a quick fix to a potential tax problem, the CP-WROS form of title is well worth considering. The change can be made by a simple deed.