Reduce Income Taxes
The Tax Trap of Joint
Tenant Ownership vs.
Community Property with Right of Survivorship
Or Probate if just Community Property
Married couples in Arizona who title their home or investment assets as
Joint Tenants with Right of Survivorship (JTWROS) lose the benefit of
“step-up-in-basis.” If ownership is just husband and wife (as Community
Property) you get the step up in basis HOWEVER, half will probably have to be
probated on the first to die – you do not want that!
Ariz. Rev. Stat. §
33-431 requires the proper title wording, "community property with right
of survivorship.” Same in California and Nevada, but Alaska and Wisconsin
require different wording.
With joint tenant assets,
when you die, your spouse only gets a 50% step-up in basis.
But if you title
assets as Community Property with Right of Survivorship (CPWROS) upon the first
to die, the surviving spouse gets 100% tax free step-up in basis avoiding any
taxable gain on future sales.
For example: You have investments worth $200,000 with a
tax basis (your cost) of $100,000. When
you die your spouse sells the assets for $200,000. If held as joint tenants,
the spouse would have to pay taxes on half the gain - $50,000. By contrast, if
held as Community Property with Right of Survivorship the spouse would have
ZERO gain to pay taxes on!
On your personal
residence you may qualify for the $500,000 capital gain exclusion for married
couples. But in order to get the $500,000 home exclusion the surviving spouse
has to sell the property in the year of the death, otherwise the exclusion is
$250,000, the same as for single people.
But there is no
exclusion for investments, so it is even more
important to consider holding investments as CPWROS. Unless they decline in value!
Of the nine states that are community property states only five - including
Arizona - recognize the title of CPWROS.
Since only a few
states have CPWROS not all brokerage firms are set up to allow this title on
accounts. We can open an investment account with
this title.
Other considerations:
Obviously if you
have separate assets before marriage and have kept them segregated you would
not want to have them in either a joint or CPWROS account, since they would
lose their separate status.
Assets held in a
Living Trust avoid the taxation problem. You can not take advantage of this
titling in retirement plans, IRA’s or annuities, since they have direct beneficiaries
and different tax rules.
If the spouse that
is likely to die first has possible judgments pending you may not want to use
CPWROS, since these assets can be attached by creditors of the deceased spouse.
CPWROS can only be
used for married couples. If you do not have a spouse, Arizona Beneficiary
Deeds for real estate enjoy a 100% step-up in basis vs. only 50% if you own it
with another heir as joint tenants. For single
people on non-real estate assets you can use “Transfer on Death” titling to
avoid probate.
CPWROS status can be
created without the need for a "straw person," which is required with
Joint Tenancy deeds with rights of survivorship, and the right of survivorship can
be terminated by the recording of an affidavit if you change your mind.
With the large
decline in Arizona real estate values in the last few years, some folks may not
have gains but losses if they bought before the
decline! You cannot deduct losses on
homes, just the gains are taxed. If you
think a spouse is likely to die before you are back to a gain position, you may
wish to reverse course and title as JTWROS since the tax basis value is
determined at date of death (or six month alternative date) – so you wound what
to avoid a step-down in basis upon death!
This may also apply
to investment assets after the 2007-2008 declines, however with the strong
market recovery over the last few years this is less of a concern. In early 2013, gold has reached new recent
lows… it gets very complicated and a crystal ball is needed. However, historically most assets have had gains,
so then you want to use CPWROS both for tax savings and to avoid probate.
Another Danger of Joint
Tenancy:
Can Transfer Without Consent
of Joint Tenant
Of course your
spouse would never do this… but it does happen.
A spouse has an
affair and unknown to the other spouse, he (let’s assume it is the husband)
secretly gave his mistress a deed to the house or transfers other jointly held
assets to her.
Guess what? The wife now owns the assets with the
mistress! (Probably not what either desired.)
With joint tenancy
any owner can transfer his interest without the knowledge or consent of the
other joint owner. He can only transfer his 50% interest, so the wife and the
mistress now own the home or other assets as tenants in common.
If the assets were
held as CPROS, both spouses must consent to any transfer of interests.
The above is for informational purposes
only concerning titling of
assets and is not intended as definitive legal or tax advice. You
should not act upon this information without seeking independent legal counsel.
If you desire legal, tax or other professional advice, please contact your
attorney or qualified tax advisor.
Resources:
Ariz. Rev. Stat. § 33-431
http://www.nolo.com/legal-encyclopedia/free-books/avoid-probate-book/chapter6-5.html
http://en.wikipedia.org/wiki/Community_property
http://www.ggu.edu/school_of_taxation/tax_news/attachment/Jim+Henderson+Article.pdf