When I recently looked over how 14 of my clients held title to their homes I was not surprised to see that title was held as, hypothetically, Joe Smith and Mary Smith, as joint tenants. Most likely my clients did this because their real estate agent told them to hold title this way because joint tenancy is the easiest way to handle the transfer of property upon the death of a spouse. Simply stated, the surviving joint tenant acquires the decedent spouse’s interest the moment the spouse dies. There is no probate, no trust administration or any other estate planning arrangement involved in this process. Rather, by operation of law, the interest automatically passes from one spouse to the other immediately upon death. For example, upon Joe Smith’s death, Mary Smith would simply present an affidavit of death of Joe Smith to the probate court and Joe Smith’s name would be removed from title, thereby leaving Mary Smith as the sole owner of the property.
While your real estate agent might think it is a good idea to hold property as joint tenants, a California attorney would advise otherwise, for there are significant tax reasons for holding property in a form other than joint tenancy. The following illustration provides an example of the problem involved with holding property in joint tenancy.
Joe and Mary Smith, a married couple, purchased a home in 1980 for $100,000 in Santa Cruz, CA. They took title as Joe Smith and Mary Smith as joint tenants. In 2004, Joe Smith passed away and thus Mary Smith became sole owner of the property because she was the surviving joint tenant. In 2004, the value of the home was $1,000,000. Also in 2004, Mary decided to sell the home for $1,000,000.
The tax Mary had to pay for the sale of the home is called capital gains tax. Capital gains tax is imposed on the gain of an item by deducting the cost basis of the item when it was originally acquired from the sale price of the item. In particular here, the cost basis of an inherited asset is the value on the date of death.
In this case, Mary acquired of the property in 1980 for $100,000. Then in 2004, Mary acquired the other of the property for $500,000 through the death of her spouse Joe. Thus, her cost basis would be $550,000, since you could add basis, and when she sold the house for $1,000,000, her gain would be $450,000. In 2009, capital gains tax is roughly 25% (15% federal/9.8% California)
Had title to the house been held as “community property” there would have been significant tax savings. For example, upon the death of Joe, Mary would be entitled to receive a new cost basis for the entire value of the home, $1,000,000, instead of the 50% as in the case of the home being held in joint tenancy. Therefore, Mary would not have any capital gains tax due because her inherited cost basis would be $1,000,000 and the selling price was also $1,000,000. In sum, Mary could have saved plenty in capital gains tax had she and Joe titled their property as community property instead of joint tenancy.
Finally, the principal benefit of joint tenancy, little post-death administration, can be replicated if title is held as “community property with right of survivorship.” However, the IRS has yet to rule if holding title as community property with right of survivorship entitles the surviving spouse to acquire the property with a new cost basis for the entire property, rather than 50%. Regardless, holding marital real estate as “joint tenancy” is not advisable in most situations.