New kind of title can ease taxes

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By C. Forrest Davis, EA

The Arizona legislature recently passed a law which gives married Arizonans a new way to hold title to property and potentially save on taxes.

The new provision is called "Community Property With Right of Survivorship" and combines the best features of two traditional means of owning assets. In the past, the most common ways for married couples to hold title was as "community property" or as "joint tenancy with right of survivorship" (JTWROS).

Arizona is one of nine community property states (most are in the Southwest), where "community property" is the default for ownership and has tax advantages. However in the past, most couples seem to have chosen JTWROS for simplicity, believing that legal costs would outweigh the potential tax savings.

Simplified probate

The new law provides the probate simplicity of joint tenancy to community property. It can mean a substantially smaller tax bill when the property is sold. (Remember, however, that the tax liability can be deferred or completely forgiven under some circumstances.)

Joint tenancy is used nationwide and simplifies transfers of assets upon death of a property owner. ("Tenant" here does not mean renter, as we are used to thinking, but rather a holder -- owner -- of the property.)

With joint tenancy, each person owns a portion of the entire asset, whether it is a home, investment real estate, stock or bonds. Upon death of a joint tenant, everything simply belongs to the survivor, and probate essentially is avoided.

"Stepped up basis"

Federal tax law says that someone inherits property at its market value at time of death. The other joint owner "inherits" the deceased person's portion at a "stepped-up basis."

Here's how it works: Suppose a couple bought their home 20 years ago for $50,000 and today it is worth $150,000. If they sell it, they will have income tax liability on the $100,000 "gain" (profit) they make. At 28% federal and 4% Arizona tax rates, that's $32,000 in taxes.

If one spouse died as JTWROS, the surviving spouse would acquire the other's interest at a basis (cost figure) of $75,000 (half of the market value). Added to that spouse's previous basis of half the original cost ($25,000), that gives a basis for computing taxable gain of $100,000. A sale for $150,000 by a widow or widower would result in a tax liability of only $16,000 on a gain of $50,000 -- a big savings.

Community property goes a step further. Each spouse is considered to own the entire property, so the basis is stepped up for the entire property (not just half). In our example, that would result in a tax liability of ... zero!

The down side of community property is the additional legal expense required to process the property through probate. The changes to Arizona's probate law adding the survivorship clause allow CPWROS to be handled like joint tenancy, skipping the lengthy probate process.

Joint tenancy still around

Joint tenancy is not obsolete. Community property applies only to married couples, while anyone, related or not, can be joint tenants.

Community property with right of survivorship is not automatic. Unless a couple specifically choose it (or JTWROS), title will be recorded as regular community property.

Married couples who own their homes now as joint tenants can switch to the new community property with right of survivorship by recording a new deed. It does not affect their mortgage. Several local title companies will handle the paperwork for a modest fee. As with any other important legal and tax decision, you should check with your attorney, tax advisor and estate planner first.