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Legal Title

When buyers open escrow, they need to specify their vesting. ‘Vesting’ is the way you want to hold title to the property.

Here are the options you have to choose from to hold title:

 

 

What form of holding title is right for you?

The answer is complicated because it depends on you, any people who are going on title with you, and deals with tax, inheritance, and transfer issues. Since title crosses paths of several different professionals, you will need to talk with a few people. I recommend speaking with an accountant, a real estate attorney or estate planner, and/or a probate attorney.

If you are single, then Sole ownership will probably be best. Tenants in Common, Joint Tenants, Community Property, and Community Property with the right of survivorship, are all group forms of ownership.  These are all free options. I address Business Entities and Trusts and Estates separately because most residential buyers do not need them.

It is important to note that sole ownership, Tenants in common, Joint Tenants, and Community Property provide no liability protection for owners. Only business entities can provide limited liability.

Right of survivorship is an inexpensive estate planning tool that avoids the expense, lengthy, and complication probate process, and saves the cost of  having an attorney write a will or create a trust.

Sole Ownership

There are no special tax or other advantages of holding title in sole ownership. When the sole owner dies, the property goes through probate.  This is the way most single people hold title.  The deed for a sole ownership is recorded as “John Doe, a single man”.

Occasionally a married couple will choose to hold property as Sole Ownership. This situation comes up when one spouse owned the property before getting married, and wants to ensure their spouse doesn’t acquire a community property interest in the property. California is a community property state, and ownership of the property held in the community is split 50/50 between spouses or domestic partners.  Title would be recorded as “Jane Doe, a married woman as her sole and separate property”.  You have to be very careful if you are married and you are trying to hold property as sole ownership- speak with a family lawyer who can explain it in more detail, the state can declare in court sole ownership property as community property if funds are commingled or it is shown that it was indented to be held in the community. Occasionally a spouse who has good credit will take title as Sole Ownership when the other does not because lenders will give them a reduced interest rate by having the “good credit” spouse take title to the property as a sole owner, and having the “bad credit” spouse Quitclaim (give up) all their rights to the home.

 GROUP OWNERSHIP

 

 

Tenancy in Common

Tenancy in common offers the most flexibility of transferability and ownership division for group ownership. An owner can sell their interest in a tenancy in common without the permission of the other owners and without the need to sell the entire property (although banks usually don’t like to lend on TIC interest so the sale of an interest will probably need to be cash). In addition, Tenant in common ownership can be divided anyway, and does not need to be equal. You could have three owners, with one owning 50% interest, another owning 30%, and the other owner owning 20%- no other form of group ownership aside from Business Entities and Trusts allows you to do this. Tenant in common is generally the vesting chosen by small investors, or unrelated and unmarried owners holding title in a group. Tenancy in common can still be used by married couple but they usually choose to hold title as community property because of the tax advantages and possible estate planning advantages.  Tenancy in common ownership goes through probate.

Joint Tenancy

 There are two primary advantages to Join Tenancy: right of survivorship and a half stepped up tax basis. The right of survivorship is an inexpensive estate planning tool that avoids probate. Joint Tenancy is usually used for family members or unmarried couples that want their interest in the property, upon their death, to automatically transfer to the surviving joint tenant(s).  Joint tenants can be married too. One disadvantage of joint tenants is that ownership interest has to be equally divided among owners unlike tenants in common. So if there are two joint tenants, then they must own the property 50%/50%. If there are three joint tenants, then they own the property 1/3, 1/3, 1/3. The right of surivivorship which is Joint Tenancy’s advantage could also be its disadvantage if you don’t want the joint tenant to inherit your interest and want it to go somewhere else.

Example of tax advantages of half stepped-up basis of 50% for Joint Tenancy:

Suppose two people bought a property in 1990 for $200,000. The property is now worth $1,000,000. Each owner has an original basis of $100,000 (half of the original purchase price). When on joint tenant dies, the other joint tenant receives a step up in the basis on the half of the property that is transferred to them through right of survivorship. So in this scenario, the surviving joint tenant’s original half still has a basis of $50,000, however the second half transferred receives a stepped up basis to the current market value of the property at the time of death of the co-tenant, which would be $500,000 instead of $100,000. What does this mean?

The basis for the property is used to determine the capital gain upon sale. The long-term capital gain tax rate is 20%. If you sold the property for $1,000,000 with no stepped up basis, the capital gain would be $800,000- which is well above the capital gain exemption of $250,000 for single person, and $500,000 for married couples. In this scenario $550,000 would be subject to capital gains tax which would be $110,000 in capital gains tax.

Since the basis steps up to $500,000, the capital gain is only $400,000 ($1,000,0000 sale price – $500,000 basis on ½ and $100,000 on other half) when the property is sold for $1,000,000. After subtracting $250,000 for the single person capital gain exemption, this leaves $150,000 capital gain that is subject to tax which would be $30,000 in capital gains tax.

This is a tax benefit you do not get with Tenants in Common. However Community property offers an even bigger tax advantage than joint tenancy but is only for people who are married.

Community Property

 Community Property is only for married couples including domestic partners. California is a community property state. This means assets acquired by either spouse during a marriage are considered community property. Community property offers the best tax advantages (even better than Joint Tenants) but must go through probate (Probate code Section 100a). Each spouse has the right to dispose of his or her half of community property by will. Absent a will, title to the decedent’s half of the community property passes to the surviving spouse (Family Code Part 4, Division 4, Section 1100). Community property is usually best for married couples with adult children, or mixed families, although if the estate is very large or complicated a trust could be better.

Keep in mind that community property is liable to creditors to pay for either spouse’s debts, even debts incurred before marriage. If one spouse has debt and credit problems this may not be the best way to hold title.

Example of tax advantages of stepped-up basis of 100% for Community Property:

Suppose a married couple bought a community property in 1990 for $200,000. The property is now worth $1,000,000. Each owner has an original basis of $100,000 (half of the original purchase price). When one spouse dies, the surviving spouse and the heir or next of kin who inherits the other half receives a step up in the basis on the entire property. Let’s assuming in this example that the other half of the property goes to the surviving spouse.  The surviving spouse now has a basis of $1,000,000 for the entire property, instead of $200,000. What does this mean?

The basis for the property is used to determine the capital gain upon sale. The long-term capital gain tax rate is 20%. If you sold the property for $1,000,000 with no stepped up basis, the capital gain would be $800,000- which is well above the capital gain exemption of $250,000 for single person, and $500,000 for married couples. In this scenario $550,000 would be subject to capital gains tax which would be $110,000 in capital gains tax.

Since the basis is stepped-up to $1,000,000, the capital gain is $0.00, when the property is sold for $1,000,000. In fact an additional $250,000 of appreciation is shielded from capital gains if you do not sell immediately. But if you sold it immediately, there would not be any capital gains tax.

Community Property with Right of Survivorship

Community Property with the right of survivorship is only for married couples including domestic partners. It combines the tax benefit of community property with the right of survivorship of joint tenancy. You get the 100% stepped-up basis, and you avoid probate. When the first spouse dies, their interest in the property is automatically transferred to the surviving spouse. Community Property with Right of Survivorship is usually the best way for married people with no children, or minor children to hold title.

Keep in mind that community property is liable to creditors to pay for either spouse’s debts, even debts incurred before marriage. If one spouse has debt and credit problems this may not be the best way to hold title.

Example of tax advantages of stepped-up basis of 100% for Community Property w/ Right of Survivorship (Same as Community Property)

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