Property - Joint Tenancy

Joint tenancy property is not community property

In a recent conference with one of my clients, a discussion developed about whether or not title to their real property interest and shares of stock should be held in joint tenancy. The primary reason the couple wanted to have the property in joint tenancy was to avoid probate. I  pointed out to them that they would have to execute a community property  declaration to avoid adverse tax consequences, if they wanted their   assets held in joint tenancy. The reason for this is because of the recent Tax Court case in May of 1998, entitled Wayne-Chi Young v.  Commissioner ("Young Case"), where the court rule that assets held in  joint tenancy does not mean they are community property in California. 

In a community property state, such as California, one of the last major tax loopholes available to couples is the step up in basis of both halves of community property, when the first spouse dies. For example, a couple purchased real property for $200,000 and it is worth $800,000 on the date of the first spouse's death. IRC Section 1014 allows the basis (original cost $200,000) in the property to step up to the fair market value ($800,000) upon the death of the first spouse. This applies to both halves of the community property. Therefore, if the surviving spouse would want to sell the real property, he or she could sell the real property for the $800,000 value and would not have to report any income on the sale.
This favorable tax treatment will be denied to a couple if community property was held in joint tenancy in California, and the survivor cannot prove the property is community. If the survivor cannot prove the property was community, using the above example, only the decease spouse share of the community property would receive a step up to the fair-market value. Therefore, under our example, the survivor would have to pay income tax on one-half of the property, i.e., a $250,000 gain ($350,000 - $100,000 = $250,000) on the sale of the property. In the case of appreciating California property, this is disastrous.

What occurred under the Young Case is that the court review the California law, and determined California does not have any statutory
language that allows joint tenancy property to be deemed to be community property. Any oral assertion that the joint tenancy property is
community will not work in tax court. Let's review some of the facts of the Young Case to see what happened.

The facts indicate that the husband and wife acquired five parcels of real property, in each case taking title as joint tenants with right of
survivorship. When the husband's estate tax return was filed, the spouse, Tsai-Hsiu Young, as executrix of the estate, excluded half of
the value of the property on the grounds it was community property, and also claimed a 15 percent discount valuation under the authority of
Propstra v. United States. Young also filed a spousal property petition in the Superior Court of California, County of Los Angeles, from which
that probate court determined the real estate was community property and set it aside to the surviving spouse.

The Tax Court started with the proposition that under California law, joint tenancy and community property are mutually exclusive forms of
property ownership. While there is strong presumption that property acquired during marriage is community property, there is a rebuttable
presumption that the character of the property is joint tenancy as set forth in the deed. No evidence other than the probate court's final
order declaring the property as community property was offered for the basis of its determination, the Tax Court noted. It also found the
testimony of the surviving spouse - that she and her husband had relied on a real estate broker's advice to jointly own the property to avoid
probate, that they thought the property belonged to both of them and that they each owned one-half of it - was not persuasive. Noting that
Young did not speak, write, or understand English, the Tax Court found there was no "mutual understanding" between her and the decedent and
that the property was community.

The Tax Court refused to recognize California property held in joint tenancy by a decedent and his wife as community property, despite an
earlier determination by a local probate court that it was community property. The Tax Court ignored the California court determination, finding that the parties did not intend the property to be community property, nor had they effectively transmuted it from joint tenancy into community property.

As to transmutation (changing separate property to community), the Tax Court noted that an oral transmutation would have been effective for one
parcel acquired before 1985, but a written transmutation is required for the other four acquired after January 1, 1985. The court found no evidence of oral or written transmutation, and that a declaration in the decedent's will which referred to "community property" but not joint
tenancy was not an "express declaration" necessary for an effective transmutation. Bottom line, the court concluded, was that the property
is joint tenancy, not community property.

The ruling cites Rev. Rul. 68-80, 1968-1C.B. 348, which held that where property was acquired by a husband and wife as tenants in common in
exchange for community assets, it constituted separate property under state law. Note the following important language in the ruling:

"However, the controlling factor was the state law determination that the property did not constitute community property."

All the ruling really says is that if the joint tenancy property would be treated as community property under state law, the federal government
will follow that result and not attempt to apply a separate federal test to determine its status as community property. The ruling goes on to
apply state law to find that the declarations in the joint wills prevented the transmutation of the property from community to separate.

It concludes: "If the property held in a common law estate is community property under state law, it is community property for purposes of
Section 1014(b)(6) of the Code, regardless of the form in which title is taken."

Assuming this is still the IRS position, the decision in Wayne-Chi Young may well be unique to California, which appears to be the only community property state that has not taken at least some action to eliminate the problem of disparity between treatment under state and federal law.

Nevada and Wisconsin (following the Uniform Marital Property Act) solved it by creating a new form of title "community property with right of
survivorship." Idaho, Texas, and Washington have various provisions permitting spouses to agree to a right of survivorship in community
property. New Mexico has determined that an inter-spousal joint tenancy with right of survivorship is really community property with right of
survivorship. Arizona does not permit spouses to take title as joint tenants unless they specify in the deed or a related document that the
property will not be classified as community. Louisiana, being a civil law jurisdiction, really does not have the problem.

I have been advised the California legislature is supposedly going to correct by statute the results of the Young Case. Until this occurs, the
safest thing a couple can do is to execute a community property declaration, if any of their appreciating assets are held in joint
tenancy.

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