How to Hold Title to Real Property

By Stuart G. Schmidt, Esq.

The most common advice on how a married couple should hold title to their home or other real property is to hold title as “joint tenancy”. This advice, often given so the couple can avoid Probate, fails to consider important tax considerations. As of July 1, 2001, people are given a new choice and can hold title as “community property with rights of survivorship”. Although this form of ownership is an improvement over joint tenancy, it is still not the best solution because it fails to plan for estate tax which can cost hundreds of thousands of dollars.

Avoiding Probate: Taking title in joint tenancy is often recommended because it allows a married couple to avoid probate upon one of their deaths. A new form of ownership, community property with rights of survivorship, will also meet this end. Although many people fear the “dreaded” probate process, rarely do they know what probate is. Probate is merely the court process of ensuring that assets belonging to the decedent are distributed according to his or her last will, or California law if no will existed, and that all creditors are paid.

Probate is to be avoided because of its expense, delay and its public nature. While not required, most attorneys handling the Probate seek compensation based on California Probate Code §§10800 & 10801 which fixes the attorney and the executor’s compensation based on the value of the decedent’s estate. Based on this system, the total fee to handle an estate valued at $500,000 would be $ 26,000 and an estate worth $1,000,000 would entitle the attorney and the executor to equally share a fee of $46,000. In addition to the expense, Probate can be a slow process and will take a minimum of nine (9) months. In fact, it is not unusual for a Probate to take as long as 1-2 years. Probate, as with almost all court proceeding, is a public proceeding which means that all records filed in Probate are public. The extent and amount of the decedent’s assets will become public knowledge as well to whom the decedent gave his or her assets.

Income Tax Savings – the stepped up basis: While the expense and inconvenience of probate can and should be avoided, focusing on probate alone when deciding how to hold title to real property can be a costly mistake. An important consideration, which should not be overlooked, is the income tax ramifications upon a death. Pursuant to Internal Revenue Code §1014, when a person passes away the income tax basis of his or her property (the amount he or she paid for the property) is raised to the fair market value on the person’s date of death. This increase in basis allows the recipients of the property to sell it without paying income tax, assuming it did not appreciate beyond the properties value at death. Under these rules, if the decedent was married all of the couple’s community property, even the ½ interest the surviving spouse owed, would be entitled to this tax basis increase. This allows the surviving spouse to choose to sell any of the couple’s property and pay no income tax. But beware, property held in joint tenancy is not community property and only ½ of any such property would be entitled to this income tax basis adjustment.

Estate Tax Savings – A Living Trust: The best way for a married couple to hold title to real property is as trustees of a living trust. This will ensure that Probate will be avoided, income tax will be reduced upon sale of assets and that the maximum amount of estate tax will be avoided.

Upon the death of an individual an estate tax will be assessed on all property owned. However, before the tax is assessed a credit against the tax is allowed. Currently this credit allows a single person to exempt $5,340,000 worth of property from tax. In addition to this important credit there is an exemption for any property which passes to a spouse. While this marital exemption is extremely valuable in that it assures there will never be a tax upon the first death, it can cause a larger tax upon the second death. Without planning through a trust, the marital exemption can actually result in more estate tax being paid upon the second death.

To illustrate this problem, let’s assume a married couple has total assets of $10,680,000. If upon the death of the first spouse all assets are given outright to the surviving spouse, no tax will be due. However, upon the second death only one credit of $5,340,000 (assuming a death in 2014) will be given and remaining $5,340,000 will be taxed at 40%. By failing to plan for the use of both of the couple’s credits, they lost one credit which caused an estate tax of more than $2,000,000. Although there is now a “portability” provision in the law to help minimize this result, using a Bypass Trust to leave property to a spouse is still the best planning option for a number of reasons as described below.

A proper living trust will avoid this problem of loss of the first spouse’s credit amount by use of an exemption trust. Under this plan, the credit trust (also known as a bypass or exemption trust) will receive $5,340,000 worth of property upon the death of the first spouse. This property given to the credit trust is sheltered by the first spouse’s $5,340,000 credit. The surviving spouse can be the trustee of the trust and can have full use and access to all property for his or her life. When he or she passes away, all property in the credit trust (including any appreciation) will not be subject to estate tax. Only the property which is outside of the credit trust will be taxed and the second spouse to pass away still has his or her $5,340,000 credit to shelter any such property.

By creating a living trust, a married couple can plan around all the traps of death including probate, income tax and estate tax. Although, holding title as “community property with rights of survivorship” is the next best alternative, it fails to account for the estate tax which can result in a substantial tax burden which equally 50% of all assets. Clearly, the creation of a living trust for most couples is the only real solution.

It is time to review your estate plan. If you don’t yet have an estate plan, it’s time to learn about the benefit of estate planning and get it done. Your death or incapacity will be emotionally traumatic for your family; don’t make it legally difficult as well. Contact one of our estate planning attorneys , Stuart G. Schmidt or David J. Lee, to assist in the creation, review and/or update of your estate plan. Our job as your attorneys is to make this process easy and painless and, most importantly, put a proper plan in place. Call us today at (408) 356-3000 or send us an email at sschmidt@smwb.com.