Most married couples’ cornerstone of estate planning is transferring their biggest asset: their home. So teams must be aware of the many roads this process can take. Married couples who own real property have many options when deciding how to share the asset. Traditional approaches include joint, tenancy in common, tenancy by the entirety, and community property. All have advantages and disadvantages. Joint tenancy is a form of concurrent ownership where each owner has an equal interest in the property. It is also available to unmarried couples, though I will focus on married couples in this article.
Arguably, the most useful feature of a joint tenancy arrangement is the “right of survivorship.” When the first spouse dies, their stake in the property passes directly to the surviving spouse without probate administration. During probate, a court determines the validity of the decedent’s estate documents and helps to settle any claims against the estate before the property is distributed to the heirs. Avoiding this process can save the beneficiary of an estate substantial costs and time. The surviving spouse also gains additional privacy by preceding probate since the probate process is a matter of public record.
Tenancy in common usually does not have the right of survivorship. However, it allows other customizations and offers greater flexibility. As in joint tenancy, tenants in common do not have to be married; unlike in joint tenancy, tenants in common may hold unequal interests in the property. Tenancy in common is not dissolved when one of the tenants dies, either. If John and Jane are tenants in common, each with a 50 percent interest in their property, John can bequeath his 50 percent to their son John Jr., and Jane’s claim will remain unaffected.
READ MORE :
- iPhone Apps and Android Apps Play an Increasing Role in Education
- Why does only Nintendo understands handheld gaming
- 10 Health Problems Caused by Computer Use and How to Win Them
- Slower iPhone, iPad, and Mac sales drove Apple’s revenue down in Q2 2016
- CBI raids former Haryana CM Hooda’s residence, 19 other locations inland allotment case
Tenancy by the entirety is available only to married couples, though Hawaii and Vermont offer options for domestic partners and those in civil unions, respectively. It is as if the property is owned by a single entity (the couple) instead of two parties for legal purposes. Neither party can dissolve the tenancy without the other’s consent, except in cases of divorce or annulment. Like joint tenancy, living by the entirety offers a right of survivorship, allowing the surviving spouse to avoid probate. It can also shield the property from creditors of one spouse only, though not from creditors to whom the couple is jointly in debt. Not all U.S. jurisdictions recognize tenancy by the entirety.
Community property laws exist in only nine states: Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin. In Alaska, couples may enter into community property arrangements but must do so by signing agreements or forming a trust. The validity of such structures is still untried on a federal level, though, and it is unclear whether the Internal Revenue Service will honor them for federal tax purposes.
Although the specifics of community property laws vary from state to state, the basic idea is the same. Like tenancy by the entirety, community property is an option only for married couples. Generally, any property acquired by either spouse during the marriage becomes community property unless it is a gift or an inheritance. Property owned before the wedding is also excluded. Spouses may enter into agreements, such as prenuptial or postnuptial arrangements, that preclude otherwise eligible property from being subject to community property laws or convert separate property to community property.
Community property has no right to survivorship. Each owner can dispose of their interest individually. As a result, most transfers will be subject to probate without additional estate planning, even if one spouse leaves the entirety of their claim to the other. Creditors can also generally reach the deceased spouse’s interest through normal estate administration rules. Community property offers the advantage of allowing a full step-up on a basis upon the death of either spouse, which typically allows the survivor to pay taxes on a smaller capital gain should the property be sold.
This is illustrated in the example below, contrasting joint tenancy with community property: John and Jane purchased a $1 million home worth $2.5 million. Jane has died, and John inherited the house. If they owned the property as joint tenants with the right of survivorship, John’s basis in the property is $1.75 million. This is because only Jane’s half of the interest is stepped up to the current market value ($1.25 million). The cost basis of John’s half of the claim continues to be based on the $1 million purchase price ($500,000).
In contrast, John’s and Jane’s interests would be stepped up to the home’s current market value if they had owned it as community property, and John would inherit the house with a cost basis of $2.5 million. This could mean a significant reduction in taxable capital gains if John were to sell the property after Jane’s death, even allowing for a potential decrease due to the home-sale exclusion rule. This would also be the case for the couple’s other property, such as investment assets.
These arrangements offer benefits and drawbacks, which may vary depending on a couple’s situation. Joint tenancy and tenancy by the entirety allow the surviving spouse to avoid probate but do not offer community property’s generous terms for a full step-up in basis in the property. Community property risks giving creditors access to the decedent’s portion of the property and allows more flexibility in the way that property is distributed. Tenancy in common offers unequal interests in the property but does not have a right of survivorship.
In certain states, couples have yet another relatively new option: community property with the right of survivorship. The law has been on the books in several states for less than 15 years. California – the state that has arguably received the most attention on the topic – first implemented these ownership rights in 2001. Of the nine community property states, Arizona, California, Idaho, Nevada, Texas, and Wisconsin currently offer the right of survivorship option. Laws also vary by state regarding which property is eligible to be titled community property with the right to survivorship. For example, only real property may be titled this way in Idaho.
The states that offer community property with the right of survivorship seek to make it easier for couples with relatively simple estates to transfer property to a surviving spouse. Before the advent of community property with the right of survivorship, married couples had to draft special agreements or use trusts to convert the joint property into community property. Community property with the right of survivorship allows married couples to take advantage of the full step-up basis while avoiding probate administration without needing more complex estate planning.