Unfortunately, owning property as "joint tenants" can seriously affect the taxation of any subsequent sale of the property after the death of one spouse. This is because the U.S. Internal Revenue Code provides special treatment for property owned by a married couple as "community property," but not for similar property owned as "joint tenants."
Thus, if Mr. and Mrs. Jones buy a house as "joint tenants" for $200,000, the IRS considers that each paid $100,000 for a one-half interest. If Mr. Jones later dies, Mrs. Jones automatically owns the entire house, and Mr. Jones' share of the house is revalued as of the date of his death. If the house was worth $400,000 when Mr. Jones died, then Mrs. Jones is treated as if she paid $300,000 for the house -- computed by adding her share of the purchase price ($100,000), to the value of Mr. Jones' share when he died ($200,000).
In contrast, the IRS treats "community property" as if it were owned completely by the deceased spouse, in applying this special "adjusted basis" rule. (For other purposes, such as computing estate taxes, only one-half of the value of community property is counted.) Therefore, if Mr. and Mrs. Jones bought their house as "community property" for $200,000, and Mr. Jones later died, leaving his share to Mrs. Jones, the entire house would be assigned a new "basis" at current fair market value.
The result is that if Mrs. Jones decides to sell the "joint tenancy" house for $400,000 shortly after Mr. Jones' death, she would realize a taxable capital gain of $100,000 (the $400,000 sale price minus her $300,000 "adjusted basis," computed two paragraphs above). If the same house were owned as "community property," however, she would recognize no capital gain, because her "adjusted basis" would be the same as the sale price.
Of course, no tax will be due from the sale of the former "joint tenancy" home if the seller quickly bought another home at the same or higher price. Also, the surviving spouse might avoid or reduce the capital-gains tax even if the house were owned as "joint tenancy," if she can still use the once-in-a-lifetime $125,000 exclusion available for the sale of a home by a person or couple over age 55.
However, to capture the best of both situations, it is possible to transfer property into a "living trust" (thus avoiding any probate court proceedings) while also retaining its character as "community property" (thus obtaining a full "adjusted basis").
It is possible to file a spousal property petition (or initiate probate) and include "joint tenancy" property in the petition, arguing that it was community property all along. However, this uncertain procedure eliminates the benefit of the joint tenancy form of title, which is the automatic transfer of title at death.
Another drawback of "community property" ownership is that the entire property becomes liable for the debts of either spouse. In addition, "community property" will usually be equally divided in case of divorce, while "joint tenancy" property can be traced to separate-property sources to permit unequal division.
However, in the recent California real estate market, this general rule hasn't always been true. If Mr. and Mrs. Jones bought their home in 1989 for $400,000, it is possible that the current fair market value might be only $350,000. If so, it would be preferable to own the property as "joint tenants" to avoid having the survivor's basis in the property reduced to $350,000. (Instead, the basis would only be reduced halfway, to $375,000.)
One proposal being considered by Congress would either eliminate the "adjusted basis" at death, or would impose a capital-gains tax on the adjusted basis at death. Although passage is unlikely, such a change would have a substantial effect on estate planning.