Can a joint living trust be structured to allow a 100 percent basis step-up?

by Mike Tucker, CPA 

Can a joint living trust having the surviving spouse as beneficiary be structured to (1) allow a 100 percent step-up in federal tax basis of a trust asset (real property) located in a non-community property state, and (2) avoid probate in that state after a first-to-die event? My wife and I are California residents and own property in two non-community property states.

It is not federal law that determines the step-up basis but state law. The step-up basis in a community property state is different from the step-up basis in a non-community property state. Regardless of how a living trust is set up, it cannot override state law.

In a community property state, jointly owned real property is stepped up 100 percent to fair market value (FMV) on the date of death of the first spouse. This is true regardless of whether or not the property is part of a living trust. (The surviving partner, however, may elect to postpone the step-up until six months after the date of death of his or her spouse.)

In a non-community property (or common law) state, property held by husband and wife in joint tenancy with right of survivorship will only have a 50 percent step-up in basis. As an example, let's say a married couple originally bought property in such a state for $250,000. One spouse dies and the FMV of the property at the time of death is $550,000—a difference of $300,000 between the old and new values. Since the property is in a common law state, the step-up basis of the property is now $400,000 (half of $300,000 is $150,000, which is added to the original price of $250,000 to figure the new step-up basis).

Whether it is a community property or non-community property state, every state has its own probate laws. Regardless, probate can be an expensive and time-consuming process. Furthermore, probate records are open to the public—something not every family appreciates. Owning real estate in different states means different probate procedures, absent any other means of transfer.

A living trust is an essential ingredient in an estate plan. But avoiding probate should not be your sole motivation. You should take into account the totality of your personal circumstances to properly structure an effective estate plan. Other ways you can transfer assets upon death are automatically by title (e.g., joint tenancy), designation in a contract (e.g., IRA or insurance beneficiary) or through death transfer statutes (an area of law not yet fully developed).

You should consult both an attorney and a CPA before drafting your estate plan. These experts can advise you on how best to structure the plan to minimize taxes and to ensure your wishes are fulfilled.

Mike Tucker is a San Jose, Calif., CPA with the firm of Just, Gurr & Associates. You can reach him at (408) 271-2700.

Have a question for a CPA? Ask it here.

In accordance with IRS Circular 230, the information on this website is not intended or written to be used, and cannot be used as or considered a "covered opinion" or other written tax advice and should not be relied upon for the purpose of avoiding tax-related penalties under the Internal Revenue Code; promoting, marketing, or recommending to another party any transaction or tax-related matter(s) addressed herein; for IRS audit, tax dispute or other purposes.