Should Your Primary Residence Be Jointly Owned? Tax Implications . . .

When planning your estate in SC, it’s important to understand how capital gains, basis step-up, and asset titling impact tax liability—particularly for married couples. This is becoming more of an issue with real estate as it has appreciated considerably in recent years, especially for people who have a very low basis (discussed below) in the property.

What is a Step-Up in Basis?

When someone passes away, most of their assets receive a step-up in basis. This means the asset's tax basis (generally what the person paid for the asset) is "stepped up" to its fair market value as of the date of death. If the asset is later sold, capital gains are calculated only on the appreciation that occurs after the decedent’s death.

Example:

If a decedent purchased a home for $200,000 and it’s worth $500,000 at their death, the new basis is $500,000. If the beneficiary sells it shortly thereafter for $500,000, there will be no capital gains tax ($500,000 sale - $500,000 basis = $0).

Primary Residences and the $250K / $500K Exclusion

In addition to the potential basis step-up, primary residences receive special tax treatment upon sale – Individuals can exclude up to $250,000 of capital gains on the sale of their primary residence. For married couples, the exclusion is $500,000.  Additional qualifications have to be met.

Joint vs. Separate Ownership:  Strategic Titling of Assets

Joint Ownership:

• Only the decedent’s 1/2 of the property gets a step-up in basis.

• The survivor's 1/2 retains its original basis.

  
  

Separate Ownership:

• If only one spouse (or their trust) owns the residence and that spouse dies first, there is a full step up in basis, which is even better!

• However, if the home is titled only in the surviving spouse’s name at the time of the first spouse’s death, there is no step-up in basis at all at that time.

  
  

Real Life Examples:

There are some issues to consider so let’s run through different scenarios to see what the tax bill might be if the surviving spouse later sells the property, making certain assumptions:

Assumptions:

• Married Couple

• Original purchase price (basis):  $500,000

• Fair market value at time of death:  $1,600,000

• Sale price after death:  $1,600,000

• Surviving spouse sells within 2 years of the first spouse’s death

• Capital gains tax rate:  15%  

Note:  None of the scenarios below matter if the surviving spouse holds onto the residence until death. But, assuming the house is sold by the surviving spouse:

Results:

Scenario 1  (First Spouse to Die Sole Ownership) = $0 in Taxes

Scenario 2  (Surviving Spouse Sole Ownership) = $90,000 in Taxes

Scenario 3  (Joint Ownership) = $7,500 in Taxes

* if you want to understand the calculations for how these results were arrived at, see the very end

So, is Separate or Joint Ownership Better?

As you can see from the above example, it’s great if the primary residence is titled solely in the name of the first spouse to die, because the survivor gets a full basis step-up.  But, we don’t know for sure which spouse will die first.  If it’s titled solely in the surviving spouse’s name when the first spouse dies, there is zero basis step-up.  If you want at least some basis step-up no matter which spouse dies first, it’s best to have the residence jointly owned so there is a 1/2 step up at the first death.

But, joint ownership does not always make sense.

When Does Joint Titling Not Make Sense?

The following are some situations where separate titling may be better:

• For asset protection reasons:

  • Some people want to put the house in the name of the spouse who is less at-risk from a liability standpoint.

• To better plan for the possibility of dealing with estate taxes

• When it’s very likely one spouse will die before the other, some couples want to title the house in the spouse’s name who’s likely to die first, thus getting a full step up, assuming the order of deaths play out that way. 

• When a spouse brings separate property into the marriage.

• In blended families where estate planning goals differ.

  
  

Final Thoughts

Thoughtful titling of assets between spouses can mean the difference between a taxable gain and a tax-free one. Combined with the basis step-up and $250K / $500K exclusion, these strategies can significantly reduce or eliminate capital gains tax for surviving spouses.

With a primary residence, again, this issue can be more of a concern if you have significant gain. Regardless, though, if you're unsure whether the current ownership structure of your primary residence makes sense, now is the time to review titling and talk through the potential impact with an experienced estate planning attorney.

Disclaimer: Please note that certain assumptions have been made and numbers adjusted for simplicity. For a more in-depth analysis of your situation, please consult with an attorney.

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Scenario 1:  Joint Ownership of a Primary Residence

At first spouse’s death:

Deceased spouse’s 1/2 basis is stepped up to $800,000 (half of FMV)

Surviving spouse’s 1/2 retains original basis: $250,000 (half of $500,000)

New combined basis: $800,000 (stepped-up half) + $250,000 (original half) = $1,050,000

Capital gain before exclusion: $1,600,000 − $1,050,000 = $550,000

Section 121 exclusion: $550,000 − $500,000 = $50,000 taxable gain

Capital gains tax owed: 15% × $50,000 =  $7,500 in Taxes

Scenario 2: Sole Ownership by Deceased Spouse

Entire property gets 100% step-up to $1,600,000

New basis:  $1,600,000

Sale price:  $1,600,000

Capital gain before exclusion: $1,600,000 − $1,600,000 =  $0  (No capital gains tax)

Scenario 3: Sole Ownership by Surviving Spouse (No Step-Up)

Original basis remains: $500,000

Sale price: $1,600,000

Capital gain before exclusion: $1,600,000 − $500,000 = $1,100,000

Section 121 exclusion: $1,100,000 − $500,000 = $600,000 taxable gain

Capital gains tax owed: 15% × $600,000 =  $90,000 in Taxes