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(And Why Does it Matter)?"

 

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Estate Planning Update
February 2012
Greetings!

When a married couple purchases a home, they usually take title to the property as joint tenants without being made aware of the alternative forms of ownership. However, this inadvertent choice may prove very costly after the first spouse dies. If the surviving spouse sells the house, he or she may owe a significant amount of income tax that could have been avoided if the couple had simply held title to the house as community property instead.

Consider the following example:  A married couple purchases a home for $1M, which means that each spouse has a cost basis of $.5M in his or her 50% share of the house. (When the house is sold, taxable gain will be determined by subtracting the seller's cost basis from the sales price.) Many years later, it is worth $2M when the first spouse dies...

What happens when the house is held in joint tenancy?

 

* When the first spouse dies, his or her share of the house receives a step up (or down) in basis to its fair market value on the date of death. Consequently, the deceased spouse's 50% share of the house now has a cost basis of $1M.

 

* The surviving spouse's cost basis in his or her 50% share of the house does not change - i.e., the basis in this share remains $.5M.

 

* If the surviving spouse sells the house for $2M, he or she owes capital gains tax on $.5M ($2M sales prices less $1.5M new combined cost basis). Currently, combined federal and state income tax rates on long-term capital gain are approximately 25% for most taxpayers, which means that the surviving spouse will owe approximately $125K in income tax as a result of the sale. Furthermore, the federal long-term capital gain rate is scheduled to increase from 15% to 20% for most taxpayers on January 1, 2013.

 

What happens when the house is held as community property? 
 
* When the first spouse dies, both spouses' shares of the house receive a step up (or down) in basis to the property's fair market value on the date of death. Consequently, the surviving spouse has a new combined cost basis of $2M in the house.

* If the surviving spouse sells the house for $2M, he or she owes no capital gains tax ($2M sales prices less $2M cost basis produces no taxable gain).

* If the house is held as community property and sold by a surviving registered domestic partner, he or she will receive a full step up (or down) in basis for state income tax purposes, but not for federal income tax purposes.

Please contact me at 323.654.9513 or brookspaley@paleylaw.com if you would like to verify or change your current form of home ownership, or to discuss any other aspect of your current estate plan.

Brooks Paley, J.D., LL.M.
About Paley Law Corporation
Brooks 0168

Paley Law Corporation is based in Los Angeles and specializes in providing personalized, sophisticated estate planning and related legal services.  Brooks Paley, J.D., LL.M., is the managing principal of Paley Law.  Brooks is quoted in the June/July 2011 issue of Working Ranch Magazine ("Death Tax Tips") on the impact of the estate tax on family-owned businesses and tax planning opportunities available to them.

The above material is provided for general informational purposes only and is not intended to constitute legal advice in any particular matter. Transmission of this material does not create an attorney-client relationship. Paley Law Corporation does not warrant the content of this material and is not responsible for any errors or omissions associated with it.

To ensure compliance with requirements imposed by the Internal Revenue Service, Paley Law Corporation informs you that any U.S. tax advice contained in this communication (including any links to other websites or material) is not intended to be used, and cannot be used, for purposes of (i) avoiding penalties imposed under the Internal Revenue Code, or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.

    

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2012 Paley Law Corporation