Taxes and Cost Basis
There are special income tax rules that apply to property owned jointly by spouses. To understand a potential disadvantage to joint ownership, you need to learn the rules about cost basis. Cost basis is the amount you subtract from the sale price of the property to compute your gain or loss when you sell a piece of property. When you die, most of the property you own on the date of your death will get a step-up in cost basis equal to the fair market value of the property at that time.
Cost basis is usually your purchase price plus expenditures such as improvements on real property or other allowable expenses. You should check the IRS rules about which expenses may be added to your cost. You should also keep track of those costs for reference if you were to sell.
For example, assume you bought one share of ABC stock for $10; $10 is your cost basis. Now assume that when you die, the stock is worth $90 a share. You owned the stock in your individual name and not in joint tenancy with your spouse, and you leave the stock to your spouse in your will. Your spouse will get a new cost basis in the stock equal to $90. If your spouse sells the stock later for $95, your spouse's gain on the sale will be $5 ($95 sale price minus $90 cost basis). If you had sold the stock while you were alive for $95, you would have had an $85 gain ($95 sale price minus your cost basis of $10).
The tax rules are different, however, if you own property in joint name with your spouse. As you know, when you own property in joint name with your spouse, the spouse owns the property automatically. But your surviving spouse receives only a 50 percent increase in cost basis plus half of the original basis.
Let us return to the earlier example. You paid $10 for the one share of stock in ABC Company and put the stock in joint name with your spouse. When you die, the stock is worth $90. Your spouse has a cost basis of 50 percent of the fair market value of the stock when you died, or $45, plus she gets to add half of what you paid for the stock, or $5. Your surviving spouse's cost basis is $45 plus $5. Now when she sells the share of ABC Company stock for $95, she has a $45 gain ($95 sale price minus $50 cost basis). Compare this to the $5 gain she would have had if you had left the share to your spouse in your will. This is a very important consequence to owning property in joint name with your spouse, since the gain may be subject to income taxes.
When spouses own property in joint name, they make a trade. They exchange the advantage of a full step-up in cost basis for the simplicity associated with the fact that joint property passes automatically to the surviving joint spouse.
Property May Go Down in Value
If the property you own has gone down in value, and you leave the property to your surviving spouse, she will take the lower value as her cost basis. For example, assume you bought one share of DEF stock for $100. The stock is worth $20 when you die. If the stock was in joint name with your spouse, her new cost basis would be $60 — half of what you paid ($50), plus half of the value of the stock when you died, or $10 ($50 + $10 = $60). If the stock of DEF had been in your individual name, your spouse would have a cost basis equal to the value of the stock on the date of your death: $20.
In this case, joint ownership with your spouse gives you a better cost basis. You would like the cost basis to be as high as possible. If your spouse sells the one share of DEF stock that had been owned in joint name for $20, he will have a loss on his return of $40 (sale price of $20 minus cost basis of $60 equals $40 loss). If you had owned the stock in your individual name and left the stock to your spouse, she would not have any gain or loss if she sold the stock for $20 (sale price of $20 minus cost basis of $20 equals no gain or loss).
If you think the income tax cost-basis rules could be a disadvantage for you, you need to read Chapter 17 about federal estate taxes. In certain circumstances, owning all of your property in joint name with your spouse could cause your family to owe federal estate taxes. Chapter 18 teaches you how this result could be avoided.
When you summarize information about each piece of property you own on a separate piece of paper for your notebook, you should compute the cost basis for each. Calculate the cost basis your spouse would receive if you owned your property in joint name and compare it with the cost basis he would receive if your property was owned in your individual name. This may help you plan.
Loss of Control
When you own all of your property in joint name with your spouse, you have no control over what your spouse does with your property when you are gone. Many people say this doesn't matter, because they are confident that their spouse is capable of managing the property. But the world is a more complicated place than it was in days gone by.
There are ways you can leave property to your spouse and not have to worry about whether your spouse will be sued and lose the property, or whether someone will try to take advantage of him when you are gone. Before you make the decision to own your property in joint name, you should read Chapters 11 through 14 and consider the advantages of creating a trust for your spouse.