Joint Tenancy or Community Property?
How Should You Own Your Home?Copyright © 1997 by Mark J. Welch, Esq.
How Should You Own Your Home?Copyright © 1997 by Mark J. Welch, Esq.
How you own your home or other real estate can have serious legal consequences. Each of the various ways to own real estate has its own advantages and drawbacks.
In California, multiple owners may hold real estate as joint tenants or tenants in common. Married couples may also own real estate as community property.
In addition, real estate may be owned by a separate legal entity, such as a corporation, partnership, or trust. Individuals then own only an interest in the legal entity, not a direct interest in the property.
In California, most couples own their homes as "joint tenants." Each spouse thus owns a 50% interest, with a right of survivorship. If either spouse dies, the survivor automatically owns the entire home (subject to any pre-existing mortgages and liens).
The key advantage of joint tenancy is its convenience, since no court proceeding (such as probate or a "spousal property petition") is required when the first spouse dies.
However, the house will be subject to probate at the survivor's death.
Special IRS rules provide a special tax benefit for the surviving spouse if a couple owns their home as "community property."
Anyone who inherits property is treated as if he or she purchased the property for its fair market value on the date of death. Thus, the tax "basis" for the property is adjusted, reducing any capital gains tax that would otherwise be due when the property is sold.
Normally, this "adjusted basis" only applies to the share owned by the deceased person -- 50% if spouses are joint tenants. However, if property is owned as "community property," the property receives a 100% adjustment to basis when either spouse dies.
Example: John and Mary Doe bought their house for $200,000. John dies in 1997, when the house is worth $400,000. If the house is owned as "joint tenants," the tax basis (originally $200,000) will be adjusted halfway (to $300,000). If the house is owned as "community property," the tax basis will be adjusted 100% (to $400,000).
If Mary sells a "community property" house shortly after John's death, there would be no capital gain and no income tax due on the sale. But if John and Mary were "joint tenants," there would be a $100,000 capital gain, and a federal income tax of $28,000.
Exceptions: Currently, capital gains taxes only apply when the survivor sells the house. No income tax is owed if the survivor lives in the house until death, or "rolls over" any gain by buying a new home of equal or greater value. Finally, a couple (or survivor) over age 55 can elect once to exclude capital gains of up to $125,000 from the sale of their residence from taxation.
This brochure is only intended to summarize some of the most common issues. It does not list all benefits or drawbacks of each form of title.
Joint Tenancy: Benefits include avoidance of probate and fast transfer of title to the survivor. However, each joint tenant must own an equal, undivided interest in the property, making "joint tenancy" inappropriate if owners have unequal shares. (Creation of a "joint tenancy" between non-spouse co-owners may also trigger gift tax.)
Since ownership transfers automatically at death, joint tenancy property cannot be disposed of by will. Creditors may attach any owner's share of the property (but not a co-owner's share). Any joint tenant may sever the joint tenancy at any time, converting it to a "tenancy in common."
Community Property: The main benefit is the 100% adjusted tax basis at either spouse's death. Each spouse may dispose of their half of the property by will. A key drawback is the need for a court proceeding to confirm transfer at death.
Only married couples may own "community property," and each spouse owns an undivided 50% of the property. Creditors may attach all community property for the debts of either spouse; community property ownership may be inappropriate if one spouse has large debts or potential legal liabilities.
Tenants in Common: Benefits include the ability to have multiple owners holding unequal fractional shares. Each owner's share can be transferred by will, subject to court confirmation (via probate or a petition proceeding). Creditors may attach only the fractional share owned by a debtor. The main drawback is the absence of automatic transfer or tax benefits at death.
Partnerships and Corporations: Ownership through a general or limited partnership, or a corporation or "limited liability company," may be appropriate for some commercial and rental properties. Special tax rules, startup costs, and California's high minimum franchise tax make corporate ownership of real estate inappropriate in most situations.
Trust: Any ownership arrangement may be structured through a trust agreement (or declaration of trust), so that legal title is held by a trustee. Survivorship rights are defined in the trust document; creditors' rights may be limited in some trusts. Property held by the trust is not subject to probate.
Married couples who seek both the probate avoidance of joint tenancy and the 100% adjusted basis available only to "community property" can obtain both benefits both by using a revocable living trust to hold their community property.
The chief drawback of trust ownership is the cost and hassle to create, implement, and administer the trust. However, a properly drafted and implemented trust can also achieve other estate-planning goals.
A Note on Estate Taxes: Despite the income tax consequences discussed above, the form of ownership between spouses usually has no effect on estate taxes (imposed on estates over $600,000).
A Note on Divorce: In the event of divorce, community property is equally divided, while other property is divided based on each spouse's contribution. At divorce, a "joint tenancy" house may be treated as community property, and a court may consider each spouse's separate-property contributions toward the purchase of property owned as "community property."
Questions? Your real estate broker or title company representative may be able to answer many of your questions, but only an attorney can provide legal advice.
Mark J. Welch is a Pleasanton attorney who limits his practice to estate planning, trust, and probate law.