Avoiding Adverse Effects of Holding California Marital Property In Joint Tenancy

Many married couples in California hold their community real property and personal property, such as investments and stock, in joint tenancy, with right of survivorship, in order to avoid probate. However, holding community property in joint tenancy may create legal, tax and other problems. When property is held by a married couple in California as community property, upon the death of the first spouse, the surviving spouse receives a significant tax benefit in that the income tax basis of both halves of the property “steps up” to the fair market value of the property as of the date of death of the first spouse. If the surviving spouse later sells the property, the taxable gain on sale would be the increase over the stepped up basis of the property rather than the increase over the original cost basis.

This can result in substantial tax savings. Prior to 2001, court decisions in California had held that when community property was held in joint tenancy, only the half of the community property held in joint tenancy by the deceased spouse was entitled to such a step up in basis, which takes away half of the tax savings of stepping up the basis of community property. This is because the legal definition of joint tenancy requires that the joint interest of each of the joint tenant spouses must be each tenant’s separate property, so joint tenancy property is presumptively not community property. Other problems regarding testamentary dispositions of the deceased spouse’s half of the property also arise when assets are held in a non-community property joint tenancy, since the community property of a spouse can be passed by will, while property held in joint tenancy automatically passes to the surviving joint tenant. This can result in family disharmony or litigation, particularly in situations involving spouses who have remarried but have children from a prior marriage. In September, 2000, to address this problem, California adopted legislation designed to create a new form of community property – community property with a right of survivorship.

Changing the title of marital community property now held in joint tenancy into this modified form of holding title should avoid the tax problems that threaten marital property held in a non-community property joint tenancy. That legislation took effect on July 1, 2001. Unfortunately, many married persons holding property in joint tenancy are not aware of that change in the law or of the risks of holding title to property in a non-community property joint tenancy. There are several other ways to avoid these risks. If the value of the property warrants such action, it can be placed into a revocable trust, which would avoid probate while permitting a step up in basis upon the death of the first spouse. Also, such a trust would permit each spouse to make testamentary dispositions of his or her portion of the community property should he or she so desire. For smaller estates, if the spouses want the property to pass to the surviving spouse, but want to obtain a stepped up basis on the entire property, they may be able to enter into a transmutation agreement, complying with requirements of the California Family Code, which can be used as evidence in any audit by the Internal Revenue Service that joint tenancy property had been transferred by its owners to themselves as community property.

However, the best way to assure that community property will pass to a surviving spouse is to change the manner in which title is held to such property so that the property clearly is held as community property with right of survivorship. This can be done by recording a Community Property With A Right Of Survivorship Deed, executed by the married joint tenants. A form for that deed is available on the Internet at http://lawkat.com/CM/Custom/Community%20Property%20Deed%20with%20Right%20of%20Survivorship.pdf.

The foregoing discussion is intended solely as a general overview of the law, is not to be considered as legal advice, and may not apply to the reader’s particular case. Readers are cautioned to consult with legal counsel of their own selection with respect to any specific situation.

© 2010 by Michael Fate

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