Q: As a married couple, should you hold your home as joint tenants or as community property?
Answer: It depends.
Before we get started, make sure you read this disclaimer. If you have any questions about your own circumstances, talk to your attorney or contact me to schedule a consultation.
When you bought your home, it’s most likely that the title company prepared a deed. Below is a picture of a real deed:
Among many things, the deed includes the name of the person who sold you the property, your name, a legal description of your property and also the legal form of your ownership. For example, if you were single when you bought the property, it probably says something like: “Albus Dumbledore, an unmarried man.”
Deeds are public documents. They tell the world who owns the property. This is important because, in our example, if Dumbledore wants to sell the property, the buyer needs to have a way to confirm that Dumbledore is the rightful owner. The buyer does that by looking at the deed on file with the county recorder. Property deeds are so important that they are sometimes kept for hundreds years to document land ownership.
When a married couple buys a home, typically the title company creates a deed for the couple. In my experience title companies usually describe the legal form of ownership as something like, “Harry Potter and Ginny Weasley, husband and wife, as joint tenants.” This special language tells the world that both Harry and Ginny are equal owners of the property. Sometimes the title company goes further and the ownership looks like this: “Harry Potter and Ginny Weasley, husband and wife, as joint tenants with right of survivorship.” This special survivorship language means that when either Harry or Ginny die, the other becomes the owner of the entire property.
In California, married couples and registered domestic partners can choose to hold their home as “community property.” If property is held as such, the language looks like this: Harry Potter and Ginny Weasley, husband and wife, as community property.” Land held as community property has an implied right of survivorship, even it doesn’t say it on the deed.
The decision to hold property as joint tenants or as community property can have a dramatic impact on each person’s property rights, their ability to shield property from a debt or judgment, and their eventual tax bill. In this article, I address only the tax impact of a joint tenancy versus community property.
To understand this we need to understand “basis”.
Imagine Dumbledore and McGonagall own Hogwarts as joint tenants after buying it from the Ministry of Magic for $1,000. They sell it to Harry for $3,000. The $1,000 paid to the Ministry is their basis. The $2,000 difference between the basis and the sales price is taxable gain and where there is taxable gain, the IRS wants a share. Dumbledore and McGonagall will need to write a check to the IRS, if their tax rate is 20%, they will need to pay $400. In the end, they will have $2,600 left of their $3,000 sale price. The same is true for you when you sell your home.
But . . . the tax law does peculiar things to the property tax basis when death is involved. It’s not magic but an act of congress. The tax basis actually increases on death. This increase in tax basis decreases the taxable gain. Let’s see how that works:
Instead of selling Hogwarts, imagine that McGonagall inherits Hogwarts when Dumbledore dies. The tax law gives her a new tax basis on Dumbledore’s half, which is now $1,500 (½ of the fair value of Hogwarts when Dumbledore died). When you add the new, stepped up basis of Dumbledore’s share to McGonagall’s own basis of $500 (1/2 the purchase price), she will have a new basis of $2,000 ($1,500 + $500). When she sells it to Harry for $3,000 and deducts her tax basis, her taxable gain is only $1,000. With a tax rate of 20%, she would write the IRS a check for $200 and keep $2,800 of the sales price.
Now, remember community property discussed above?
If Dumbledore and McGonagall were married and held Hogwarts as community property, McGonagall would inherit Dumbledore’s share just like above, but she would get a new tax basis for ALL of Hogwarts, not just Dumbledore’s half. Under community property law, McGonagall’s new basis would be $3,000.
Why is this? Tax laws are written by politicians to encourage people to do things and politicians want to encourage people to get married. This means that when McGonagall sells Hogwarts to Harry for $3,000 and deducts her new $3,000 basis, she has $0 taxable gain. She keeps the entire $3,000. And so would you.
Title to property involves complex and multiple considerations. You should always talk with an attorney before changing title or taking title to property.
Hogwarts, Harry Potter, McGonagall and Dumbldore are the property of J.K. Rowling and NBCUniversal.