By Francis A. “Nick” Jones, Esq.

As of July 1, 2001, a new form of holding title to real property became available to married couples.  California Civil Code section 682.1 created a  form of holding title known as “community property with right of survivorship,” by which a husband and wife can take title to real property that provides for both 1) right of survivorship (and thus probate avoidance) and 2) all of the tax benefits of community property, namely automatic step-up in tax basis for both spouse’s interest in the real property at the time of first spouse’s death.  As of January 1, 2005, registered domestic partners could also hold title as community property with right of survivorship.

Previously, most married couple held title to jointly owned real property either as community property or as joint tenants.  The advantage of holding title to real property is that on the death of the first spouse, both spouse’s interest in the property receives a full step-up in basis to the value as of the spouse’s date of death for purposes of calculating any gain on sale.  The disadvantage to holding title in this manner is that the property required a probate administration after the first spouse’s death.[1]  The advantage of holding title as joint tenants is that title may be cleared very simply after the first spouse’s death, eliminating the need for a probate administration.  The disadvantage is that only the deceased spouse’s interest in the real property receives a step-up in basis.

To explain the advantage of a full step-up in basis requires a basic understanding of Capital Gains Tax.  In general, if you sell something for more than you paid for it, you realize a profit or gain, and this gain is taxed.  The tax is known as the Capital Gains Tax.  As an example, if you purchased your home for $200,000 six years ago and sold it tomorrow for $800,000, you would have realized a gain of $600,000 (ignoring costs of sale).  If you lived in your home for two out of last five years, you likely qualify for an exemption on the first $250,000 of the gain (and if you are married, both you and your spouse may qualify for a combined exemption of $500,000); however, the remaining gain would be subject to Capital Gains Tax.

Generally, when someone gives you property, you receive the property at the same “basis” that the person who gave it to you had.  In the example above, if your parents gave you a house they bought for $200,000 and you sold it for $800,000, you would be taxed on the gain, or $600,000.  However, there is an exception to this rule regarding basis and the exception is this: generally, if you receive property on someone’s death, your basis is the value as of the decedent’s date of death instead of the decedent’s basis.  This means if you inherit your parent’s house and the house was worth $800,000 as of their date of death, if you sell the property you will be subject to Capital Gains Tax only on any amount received over $800,000. 

If a married couple acquires a home for $200,000 and holds title as joint tenants, and one of the spouses dies six years later when the house is worth $800,000, the surviving spouse’s basis in the house is $500,000.  To explain, each spouse’s one-half of the property had a basis price of $100,000 (the $200,000 acquisition price divided by two).  On the death of the first spouse, the surviving spouse received a gift from his or her spouse on death of one-half of the property, and this one-half of the property received a step-up in basis.  The value of the property on death was $800,000, so the step-up for one-half of the property is $400,000.  The surviving spouse’s basis in the remaining one-half interest is still $100,000; therefore, the surviving spouse’s total basis in the house is $500,000 ($400,000 in stepped-up basis plus $100,000 in original basis).  If the spouse sells the house immediately, he or she will realize a gain of $300,000, $250,000 of which is likely shielded by the homeowner’s exemption, but the remaining gain of $50,000 will be subject to Capital Gains Tax.  If the spouse waits a few years until he or she sells, the gain subject to tax could be significant.

If title to property is held as community property, when one spouse dies, the IRS allows a step-up in basis not only for the deceased spouse’s portion of the property, but also for the surviving spouse’s portion of the property, meaning the entire parcel of property receives a step-up in basis.  See Revenue Ruling 87-98 and §§ 850-853 of the California Family Code.  If a married couple purchased a house for $200,000, held title as community property, and one spouse dies when the property is worth $800,000, the basis price in the property for the surviving spouse changes to $800,000.  Given the current $250,000 homeowners exemption, the surviving spouse would have to sell the house for $1,050,000 before being subject to Capital Gains Tax.  This is very advantageous.

It is sound practice to advise married clients and clients who are registered domestic partners to take title to both real and personal property, whenever possible, as “community property with right of survivorship,” 1) to avoid probate of the deceased spouse’s interest in the property, (2) to obtain a step-up in basis of the surviving spouse’s interest in the property, and (3) to avoid any possible later disputes with the IRS as to the characterization of the property.

The only trap for the unwary practitioner in regard to new Civil Code §682.1 is that it requires the GRANTEE husband and wife to also sign or initial the deed in their favor.

Thus, after July 1, 2001, instead of the conveyance deed having the signature of only the grantor(s), the title document that transfers title as "community property with right of survivorship" should have the signatures of both the grantor(s) AND husband and wife, or registered domestic partner, grantees.