How Joint Tenancy Impacts Taxes in California

Joint Tenancy in California – What Does it Meant

Joint tenancy is a method of holding title to property, particularly real estate, that is designed to pass title to a property from one owner to others (survivors) upon the death of the owner. It is distinguished from a tenancy in common where there is no right of survivorship; i.e., the deceased owner’s interest goes to that owner’s heirs and/or beneficiaries, rather than to the other owner(s).
The common features of joint tenancy are:

(1) The present interest of each tenant must be equal in size to those of the other joint tenants.
(2) The interests of the joint tenants must vest at the same time.
(3) Characteristically , the interests of the joint tenants must arise by the same instrument.
(4) One joint tenant cannot prevent a conveyance of his or her interest to a third party; but the transferee is a tenant in common and not a joint tenant.
(5) One joint tenant cannot encumber his or her interest without the consent of the cotenant.
(6) One joint tenant cannot use the property to the exclusion of the other joint tenant.
(7) On severance of the joint tenancy by conveyance, the tenancy ceases, and the grantee does not take as a joint tenant but as a tenant in common.
(8) A joint tenant can only sever the joint tenancy with respect to his or her interest, but he or she cannot do so without consent of the other joint tenant(s).

Taxes & Financial Liabilities

In California, the most significant tax liability involved with joint tenancy property is property tax. Under Prop 13 adopted in the 1970s, real property in California is assessed at its full cash value at the time of purchase, death of the owner or placement into a trust, whichever occurs first. Subsequent new construction may be assessed but merely adding a name to the existing title does not trigger an automatic reassessment even with a change in control. Therefore, where joint tenants become the vesting owners of real property, there is usually no reassessment.
It is important for homeowners to know that if they inherit their primary residence from a parent or grandparent who was the owner-occupant, the steps you must take to avoid a reassessment under Prop 58 and thereby retain the low tax base of the parent or grandparent you have inherited the property from. In that special situation, it is very common for parents to gift a 1% interest in their property to their children during their lifetime so that their children become co-owners thereby avoiding capital gains tax. The property is not reassessed at that time since 1% ownership is not a change in control. Then, when mom dies, there is no trigger for reassessment since the above rules are followed. If mom had not taken that precaution, then her surviving children could face reassessment.
Note that Prop 58 only protects real property under special circumstances. Prop 193 protects personal property and is intended for situations in which grandparents leave real property to their grandchildren. That could create a new basis for the grandchildren when they inherit the property, but does not provide for an additional exemption of $1 million from the $7m current total limits for the value of inherited property under Prop 58. Exemptions must be claimed within 3 years from the date of change in ownership. One question is whether the protection of Prop 58 will survive future challenges particularly when the maximum exemption will be reduced every two years.

Inheritance and Estate Taxes

Inheritance and estate taxes certainly apply in California to property held in a form of joint tenancy. However, as with all forms of ownership, there are subtle nuances which require one to consider the practical effects on one’s estate plan and tax liability.
Just because a decedent leaves a joint tenant an undivided half interest in real property, does not mean that the surviving tenant gets a full step-up in basis at the death of the first co-owner.
For a one-half interest, the surviving tenant receives no step up in basis at the death of the first joint tenant.
For a one-third interest, the surviving tenant receives a full step-up, but only on the one-half interest of the decedent (the surviving joint tenant receives a full step up on their interest as well).
For a two-thirds interest, the surviving tenant receives a full step-up on the decedent’s interest and the added step-up on his or her interest.
Where a decedent truly intended that his surviving joint tenant share in his fortune, generally a deed dated after January 1, 1988, puts the entirety of his or her fortune into survival, with step-ups to both joint tenants. For property held prior to January 1, 1988, the presumption is that the decedent had not intended to leave a gift at death to his surviving joint tenant.
Therefore, for pre-1988 property, the only way a surviving tenant received a step-up in basis on decedent’s interest was if the surviving tenant were a spouse. For property vesting in two or more persons on or after January 1, 1988, the surviving joint tenant received a step-up on their respective interests and the decedent’s interest. Of course, if a third tenant owned the property his or her interest also receives a full step-up.
For example, assume a decedent owned real property which had a basis of $10,000, and a fair market value of $100,000 at the time of death. If there were three surviving joint tenants who received an ownership interest in the real property, then each of the surviving tenants would receive a step-up, and each of the surviving tenants would have a $90,000 basis. Following a sale for $100,000, the taxable gain would be $30,000 ($90,000 step-up in basis, less $60,000 basis of decedent). The tax liability will be $4,500 (15% of $30,000).
On the other hand, assume instead that there were only two surviving joint tenants – both husband and wife. Each would receive a full step-up on the surviving joint tenant’s interest, which none of those joint tenants would be required to pay estate tax on their interest.
But, because of the "special rule" contained in Internal Revenue Code Section 2040, the decedent’s interest in the real property would attract estate tax (applying the "surviving tenant rule" under California Revenue and Taxation Code Section 13331). That is, on a decedent’s joint interest in real property with a surviving spouse, there is no inheritance or estate tax liability as to the decedent’s portion of the joint tenancy interest.

Gift Tax When in Joint Tenancy

The creation of Joint Tenancy may or may not trigger a gift tax obligation. As a general rule, the transferor does not pay gift tax on the transfer, and the transferee does not have to recognize the receipt as income. When a joint tenant dies and his or her interest in the jointly held property passes to the surviving tenant(s), that transfer is not subject to tax. The value that was previously included in the taxable estate of the decedent is also excluded from the surviving tenant’s estate.
Tax Code Section 2511, however, provides that a person can choose to make a gift that is subject to gift tax. Gifting of an asset is accomplished by relinquishing enough control over the asset to be deemed the equivalent of an outright gift. The IRS considers the transfer of control to a third party for purposes of gift tax to be a transfer of ownership under circumstances in which the ownership interest is relinquished. The IRS has declared that a gift tax is appropriate in the following examples: a spouse adding their child or grandchild as a joint holder of a CD; a parent adding their son/daughter as a joint holder of a checking account; a parent adding their son/daughter as a joint holder of their savings account, home, or other real estate asset.
The above examples are considered gifts by the IRS subject to the current gift tax rate, which exceeds 40% and has a universal exclusion from the starting amount of $11,200,000.00 for 2018. The tax year in which the gift is completed will apply and will be due April 15 of the following year, (i.e., a 2018 gift will be due April 15, 2019). A timely filed gift tax return is required even if no gift tax is due. If this late gift tax return is not filed within three years of the death of the donee, then the gift will not be included in the estate tax return, if there is one.

Capital Gains Tax When in Joint Tenancy

When it comes to capital gains tax, holding an asset in joint tenancy can have significant implications, especially in California, where the state takes a stiff capital gains tax on gains derived from real estate transactions. For individual taxpayers, the amount of a capital gain is figured by taking the gross proceeds from the transaction and subtracting the basis (i.e., what you paid for the property). If you bought your home 20 years ago for $200,000 and sold it today for $500,000, you would generally have a capital gain of $300,000 ($500,000 – $200,000).
Before we begin exploring how joint tenancy can affect the calculation of capital gains tax, we should mention that there is an exception to recognizing capital gains when selling your personal residence. Under Internal Revenue Code Section 121, an individual taxpayer can exclude from taxable income/capital gains tax $250,000 (or $500,000 for married couples filing jointly) of capital gains on the sale of their principal residence. However, a homeowner can only use this exclusion once every two years (two years from the date of the earlier sale). Accordingly, the capital gain resulting from the sale of your principal residence is relevant when joint tenancy plays a role.
What happens when joint tenants sell a piece of property? The answer is: typically the capital gain attributable to a single joint tenant’s individual share of the property will be taxed to that joint tenant. In the example above, let’s say the husband bought the house for $200,000, and titled it in joint tenancy with the wife . If, during their marriage, the house appreciated in value and they later sold it for $500,000, would the full $300,000 capital gain be subject to tax to one of the spouses, or could the $250,000 exclusion apply? Because the house was the husband’s separate property and the wife has no separate property interest in it (assuming no other agreement to the contrary and that her joint tenancy interest was not community property), the $250,000 exclusion could only apply to the husband, no portion of the capital gain need be excluded under section 121. Since the tenants hold the property as joint tenants with rights of survivorship, the presumption is that the husband intended to make a present gift of an undivided interest to the wife. This is especially true if he put down the initial down payment, made the mortgage payments, and paid the house expenses which all benefited the wife.
There is an exception to this general rule when non-spouses hold property as joint tenants. In this scenario, the nonspouses are permitted to use section 121 and receive a proportional share of the exclusion available. Using our example above, if the house were the separate property of the husband who put it into joint tenancy with a nonspouse (a third party), then if the house were sold for $500,000 and the gain was $300,000, the nonspouse could use the $250,000 exclusion under section 121. The husband would have a taxable capital gain of $50,000 ($300,000 capital gain less $250,000 exclusion) and the nonspouse could exclude the entire $250,000.

Advantages and Disadvantages of Joint Tenancy for Tax Purposes

Although joint tenancy can sometimes be beneficial for tax purposes, its use is often ill-considered. This is because the interests of or consequences to the surviving owner in property passing by operation of law to a joint tenant can be inconsistent with the best tax consequences for the decedent’s estate or beneficiaries.
One of the main advantages of owning property as joint tenants is that upon the death of the first joint tenant, the decedent’s estate or heirs get a step up in basis on the entire value of the property. Step-up in basis means that if the decedent bought the property for $100,000 and at his death it was worth $200,000, the estate’s basis in the property would be $200,000 (it would no longer be the decedent’s $100,000 basis). As a result, if the property were then sold by the estate for $200,000 (at its date of distribution for beneficiaries) there would be no gain on its sale for estate, and income tax purposes, because its fair market value was $200,000 at the decedent’s date of death.
On the other hand, upon the death of the surviving owner, only the interest of the decedent who died last gets a step up in basis. Accordingly, if the surviving joint tenant bought the property for $100,000 and the other joint tenant died with a $200,000 basis, then upon the second death, the survivors would get a step up only on the $200,000 of the second-to-die spouse that passed, and not the other joint tenant’s $100,000 basis.
Thus, assuming that the surviving joint tenant receives the property at death of both joint tenants, rather than the property passing under the terms of a will or trust, it is more fiscally advantageous to have the property owned as tenants in common. The decedent’s estate or heirs would then receive a step up in basis on the property. Although the surviving joint tenant may not want to be a co-owner with the estate of the decedent with whom he used to jointly own, this can be remedied by the surviving tenant buying out the decedent’s estate’s interest in the property for its step up in basis.
The same analysis may be of governmental benefits. That is, if a requirement for receipt of such benefits is that the applicant own the property and is not enjoying a right to benefit from it elsewhere, then the surviving joint tenant would be required to divest his interest either by sale to someone other than the estate or otherwise.
Lifetime gifts are also important to consider, as the surviving joint tenant receives only a step up on the decedents’s share of the property value. Thus, a surviving joint tenant may have a gain on the sale of property transferred by gift while the decedent was alive. Furthermore, any lifetime gift of joint property results in gift tax to the donor on his or her one-half of the value of the property if the gift is made while the donor is alive, or on his or her share of the properties value if the donor dies and the property passes to the "non-donor" joint tenant by operation of law because of the donative intent when the property was placed in joint ownership. This is because the transferring of an interest in property by gift by tenants in common is taxable unless the recipient proves that he has given a proportionate sum back to the donor during the year preceding the transfer.

Answers to Common Questions

We’re happy to include this section in our client newsletter for the benefit of all of our clients.
Frequently Asked Questions – Joint Tenancy
What is joint tenancy?
Joint tenancy is a form of ownership that, for married couples, is created when both are named on legal title instruments (such as a deed), and it can also be created Holders of legal title as joint tenants are co-owners of the property, and they have the right to transfer their interests at any time.
Are there restrictions on the type of property the joint tenants can own together?
No. Almost all types of property can be owned as joint tenants in California. The only real restrictions are on forms of ownership that already impose certain restrictions on transfers, such as an LLC. While certain community property owned by a married couple may often be community property with a right of survivorship, in other circumstances it may not be advisable to use the joint tenancy form of ownership.
Does joint tenancy have gift or estate tax ramifications?
First, joint ownership may be treated as a gift for transfer tax purposes. In that case the transferor must file a gift tax return reporting the transfer. However , the transferee will be entitled at least to the transferor’s proportionate share of the basis of the property transferred, and possibly full basis depending on the manner of ownership of the property.
Estate tax will be incurred at the death of the first spouse to die if the surviving spouse owns jointly with the deceased spouse in a manner comparable to joint tenancy at his or her death (as opposed to owning as community property with right of survivorship).
When there is a transfer to joint tenancy between individuals who are not married, each joint tenant is the owner of their proportionate share of the property for income and estate tax purposes.
Are there any property tax implications?
Create on … Excluded from … Assess at … Properties of equal value When at least 3 years apart … Property tax is not reassessed until the holders of legal title are different (i.e., joint tenants) … Property tax is not reassessed (exemption for parent to child transfers); carryover of existing base year value … New base year value Unless all joint tenants are sons or daughters, property tax is reassessed … Subject to reassessment at current fair market value.