Planning for the future encompasses not only financial security but also savvy tax management. One often-overlooked strategy that can yield substantial tax savings is strategic account titling. While many married couples default to joint ownership or trust structures where both partners are listed as grantors and trustees, the nuances of individual ownership can offer significant advantages, particularly with appreciated assets.
Non-Community Property State: Spousal Step Up in Basis
Consider the case of Max and Debbie, residents of Virginia, a non-community property state. With foresight, they structured their investments across three taxable brokerage accounts: one in Max’s name, one in Debbie’s, and a joint account. In these accounts, they held shares of XYZ stock initially valued at $50,000 each.
Tragically, Max passed away, prompting a reevaluation of their estate planning strategy. At the time of his passing, the XYZ stock in each account was valued at $200,000, totaling $600,000 in XYZ shares for the couple.
The differing ownership structures of their accounts would result in varied tax treatments for the XYZ stock:
- Max’s sole ownership of XYZ stock would allow for a full step-up in basis, setting the basis at $200,000 for the current value of the stock.
- In the joint account, half of the stock would receive a step-up in basis, attributable to Max’s ownership. This would result in a combined basis of $125,000, accounting for Max’s step-up and Debbie’s existing basis.
- Conversely, Debbie’s sole ownership of XYZ stock would not qualify for a step-up in basis, leaving her basis at the original $50,000.
Following Max’s passing, Debbie would have a total basis of $375,000 for the $600,000 total value of the XYZ shares.
In most cases, joint ownership makes sense due to not having foresight of who would pass away first. In more nuanced cases, such as health issues for one spouse, having assets titled in their name individually can allow the surviving spouse to receive a full step up in basis and forego thousands in capital gains taxes.
Community Property States
In community property states, when one spouse passes away, the surviving spouse receives a step-up in basis for all community property assets, regardless of whether they were owned individually or jointly. This means that the tax basis of the assets is adjusted to their fair market value at the time of the deceased spouse’s death.
It’s important to note that the step-up in basis only applies to community property assets and not to separate property owned by each spouse individually. However, in community property states, most property acquired during the marriage is considered community property unless it was acquired by gift or inheritance, or it was designated as separate property through a valid agreement between the spouses.
Community property states in the United States include:
- Arizona
- California
- Idaho
- Louisiana
- Nevada
- New Mexico
- Texas
- Washington
- Wisconsin
Alaska is an opt-in community property state, where spouses can choose to treat their property as community property.
Presented by the Financial Planning Committee of Lake Street, an SEC Registered Investment Adviser
The information contained herein constitutes general information and is not directed to, designed for, or individually tailored to, any particular investor or potential investor. This report is not intended to be a client-specific suitability analysis or recommendation, an offer to participate in any investment, or a recommendation to buy, hold or sell securities. Do not use this report as the sole basis for investment decisions. Do not select an asset class or investment product based on performance alone. Consider all relevant information, including your existing portfolio, investment objectives, risk tolerance, liquidity needs and investment time horizon. Diversification does not ensure a profit or guarantee against a loss. There is no assurance that any investment strategy will be successful. Investing involves risk and you may incur a profit or a loss.
