Deed Your Property

by | Feb 19, 2024 | Uncategorized

How You Deed Your Property May Impact Your Spouse’s Future Tax Bill

Get A Double “Step-Up” In Your Tax Basis and Avoid Capital Gains Taxes By Properly Titling Your Assets.

Imagine you and your spouse purchased a home in Orange County in 1998 at a price of $500,000. Great purchase! Now your home is worth $1.5 million. If you pass away, can your spouse sell the home and keep all the sales proceeds without paying any capital gains tax? Yes, but you’ll want to make sure the home is properly deeded.

The purchase price of an asset is referred to by the IRS as the “cost basis.” When you pass away, the cost basis of appreciated assets can be increased or “stepped-up” to the current market value of that asset. This is done in part to avoid double taxation – the federal government imposes an estate tax on assets at death, so to avoid paying both estate taxes and capital gains taxes for assets that will be sold, your estate representative is allowed to adjust the cost basis to market value.

Take, for example, a stock purchase at $10 a share, and which later increases in value to $100 per share. Normally you would be facing a $90 capital gain per share and a significant tax payment when the stock is sold. If, however, you hold the stock until death in the appropriate form of ownership, the “cost basis” will increase to the current market value of $100 a share and the stock can be sold without incurring any taxable capital gain.

While the step-up is allowed for individually owned assets at death, certain forms of joint ownership limit the amount of a basis step-up. If your own real estate in Joint Tenancy with Right of Survivorship with your spouse, and one spouse dies, it is possible that only the half of the property that was owned by the deceased spouse would receive a step-up in cost basis. If a need arises and the survivor sells the property during life, they might face a taxable gain on the sale of their share of the property. Going back to the original scenario above ($500,000 purchase price and sale price of $1.5 million), the surviving spouse could incur a taxable capital gain of $500,000:

Original Basis = $500,000 ($250,000 per spouse)

Modified Basis = $1,000,000 ($250,000 retained basis for surviving spouse and $750,000 adjusted basis for deceased spouse)

Potential gain = $500,000 on sale price of $1.5 million

While there is a presumption that property acquired during marriage is community property, if any separate property (assets owned before marriage) was used to acquire the house, this presumption could be defeated and result in loss of a total step-up at the death of both spouses. This unfortunate tax event could be avoided by simply re-writing the deed to your property and filing it with the county recorder. In 2001, California created a type of property ownership called Community Property With Right of Survivorship. It is available to married couples and registered domestic partners. By titling assets in this manner, you become entitled to a step-up in cost basis at the death of each owner. This creates two opportunities to sell property and not incur any, or greatly reduced, capital gains tax. (Like Joint Tenancy, Community Property With the Right of Survivorship avoids probate, but you must include the “With Right of Survivorship” provision or you will trigger probate, as each spouse can dispose of their share of community property.)

If the couple that purchased the $500,000 home own it as Community Property With the Right of Survivorship, then the survivor will get a full set-up in the price of the home at the death of the first spouse, even though it is jointly owned and even if separate property was used to acquire the home. He or she can sell it for $1.5 million and not incur any capital gain. Additionally, should the survivor decide not to sell the home, and simply leave it to their children (or someone else) upon their death, the recipient will enjoy another full step-up of the value of the home upon the second spouse’s death. This means that if the home continues to appreciate and is worth $2 million at the survivor’s death, the recipient can sell the home and not pay any capital gains tax on the $2 million sale proceeds. This is a big tax savings!

This concept is not limited to just real estate assets – it also applies to investment accounts.

If you own joint property and want to take steps to minimize taxes at the death of either property owner, Community Property With the Right of Survivorship could be an extremely valuable tool.

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This article is intended for general informational purposes only. It does not constitute legal or tax advice, and no attorney client relationship is implied or formed by this article. You should always consult with a tax professional or attorney before taking any action. The information on this website is considered LEGAL ADVERTISING under applicable California law and may be considered advertising under your state’s laws and ethical rules. The responsible member for this advertising is D. Andrew Brown of Essayli & Brown LLP.