Mary* was a surviving spouse. She and her first spouse, Ryan, owned a lovely home and placed it into joint tenancy with right of survivorship. After Ryan passed away, Mary met Logan and they married. Because she had previously owned the house in joint tenancy, Mary changed the title to joint tenancy with right of survivorship with Logan as the other joint tenant.
Unfortunately, Mary passed away two years later. Her will gave all her property to the children of her first marriage. However, her children, Sam and Susan, did not receive the largest asset in her estate – Mary's home. Logan was the surviving tenant, and under state law he owned the home outright. He later passed away, and his will transferred the valuable home to children from his first marriage.
Joint tenancy for married couples is very simple and quite common. However, it is not always the best plan, especially if there is a second marriage or blended family. For first marriages, joint tenancy with right of survivorship is a very convenient way to own a home, bank account, stocks or mutual funds. However, couples should understand that there are some potential risks in holding property this way. If the couple is planning to fund trusts or the estate increases to a level that it is important to create a special tax-saving trust called the bypass trust, joint tenancy can conflict with the will or living trust provisions. Joint tenancy may also accidentally disinherit a beneficiary under the will. While joint tenancy is simple and common, it should be used with caution.
Joint or Separate Property Joint property ownership is typical for any assets acquired during marriage. However, property that is inherited or brought into a marriage is usually separate. Separate property in most states may be transferred to persons other than the surviving spouse. If a spouse inherits separate property and plans to keep it separate for inheritance purposes, it is also important to avoid commingling the separate property with other assets. If the separate property is commingled with joint property or treated as joint property by paying taxes and other costs out of a joint checking account, the separate property may be converted to jointly held property. This could significantly change the estate-plan result.
Community Property Several states allow married couples to own property as community property. Property acquired during a marriage in Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington or Wisconsin will be owned equally by each spouse. Residents of Alaska, Florida, Kentucky, South Dakota or Tennessee may sign a written agreement to create community-property status for some assets. In Alaska, Arizona, California, Nevada, Texas and Wisconsin, the community property may be held with right of survivorship. In other states, the property is owned in joint tenancy with right of survivorship, but there is a separate agreement that states the property is community property. In both cases, when the first spouse passes away, the second spouse is now the owner without going through the probate process.
Saving Capital Gains Tax There is a very important capital gains tax benefit for the surviving spouse if it is possible to hold the property as community property. When property that has been acquired appreciates in value, there is a capital gains tax due upon sale. For example, if stock were purchased for $25 and increased in value over several years to $100, upon sale the $75 of appreciation would be taxed as long-term capital gain.
If stock or land passes through an estate, the person receiving the property may benefit from a step-up in basis. For example, if a share of stock bought for $25 and now worth $100 is transferred through an estate, the cost basis to the beneficiary is also $100. They may sell the stock for that amount with no capital gains tax.
Tax-free Sale With community property, a married couple could jointly purchase 100 shares of stock for $50. The 100 shares then appreciate to $200. If one spouse passes away and the 50 shares are given to the surviving spouse, they receive a step-up in basis on both portions and now may sell the stock for $200 with no tax. However, in a state that does not follow the community property rules, with joint tenancy only the 50% of the stock owned by the deceased spouse gets a stepped-up basis. In effect, the stock is divided in half, and the cost basis is $25 on that share with a fair market value of $100. When that stock passes through the estate, the basis is stepped up to $100 and it may be sold with no tax. But when the surviving spouse also sells the stock for $100, they still have $25 of cost basis and $75 of taxable gain on the stock.
Therefore, if community property status is available and a surviving spouse might desire to sell assets without paying any capital gains tax, it is important to be certain the community property title is created.
*Please note: The names and image above are representative of a typical donor and may or may not be an actual donor to the organization.
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