For estate planning, is real estate considered community property or joint tenancy?

by Barry S. Phillips, CPA

How do you and your spouse hold title to your principal residence, vacation home and other real estate holdings? From a tax perspective, it can make a world of difference. This is because the law allows a 100 percent step-up in basis for "community property" assets and only a 50 percent step-up in basis for assets held in "joint tenancy" form.

What does it mean to have a stepped-up basis?

Well, let's say that you and your spouse purchased a vacation home in Palm Springs for $100,000 in 1981. If the home is now worth $250,000, you have a $150,000 built-in gain ($250,000 market value less $100,000 tax basis), which could result in more than $45,000 in federal and state income tax if you sell the property today.

If you own the home as community property and defer the sale until after your spouse dies, the entire gain goes away. This is because you get a 100 percent step-up in basis on your spouse's death. In essence, you get to pretend you bought the property for $250,000 (full fair market value) on the date of your spouse's death. Accordingly, if you sell the home, your taxable gain is $0 ($250,000 sales price less $250,000 tax basis).

If you own the property as joint tenants, you only get a 50 percent step-up in basis. You get to pretend you purchased your spouse's 50 percent interest in the home for $125,000 ($250,000 market value multiplied by 50 percent). You add this to your $50,000 tax basis ($100,000 original cost multiplied by 50 percent), which gives you a $175,000 basis ($125,000 plus $50,000). If you sell the home, you will have a taxable gain of $75,000 ($250,000 sales price less $175,000 tax basis), resulting in upwards of $22,500 in federal and state income tax. All of which could have been avoided. 

Although California is governed by community property laws, do not assume your real estate holdings are community property. You must look at the deed of title, which is on file at the county recorder's office, to be sure. If the deed shows you own the property as joint tenants, consider retitling it to community property. Lawyers and CPAs usually charge a nominal fee (less than $250) to perform this service. A little bit of planning now can save you thousands of dollars in taxes down the road.

Barry Phillips specializes in taxation, with emphasis on divorce and estate planning matters. He can be contacted by calling (626) 915-0610 or via e-mail at bp@barryphillips.com.

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