Wisely Vested Marital Assets May Lessen the Financial Burden on Surviving Spouse

Q. My father died recently, and my mother is about to sell the house. Even after the $125,000 exclusion, she will face a significant capital gain. My father also had a portfolio of stocks, some of which are completely worthless now. Can my mother sell the stocks for a loss now to offset the gain on the house? Both the house and the stocks were held jointly.

--J.S.F.

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A. You and your mother may be in for some good news, possibly even some great news.

First, you must determine precisely how your parents held their assets; typically it is either as joint tenants or as community property.

If they held them as community property, the tax basis of the entirety of those assets is generally set as of your father’s date of death. (The executor of the estate may elect to use an alternative valuation date, but this is the exception, not the rule.) This can be a huge boon to your mother because it means she will be allowed to pocket as profit the untaxed appreciation of the family home between the time of its purchase and your father’s death when she sells the house.

How does that translate into realdollars? Let’s say they purchased the house for $50,000 dec-ades ago and it was worth $300,000 when your father died. If your mother sells it for $300,000, she will not have a taxable gain to report to the Internal Revenue Service. And she will not have had to use her $125,000 exemption!

However, if they held their property as joint tenants, only the tax basis of your father’s half will be set as of the assets’ value on his date of death; your mother’s half of the assets will continue to carry their original tax basis. The impact is best illustrated by what would happen to the same $300,000 house used in the previous paragraph.

The tax basis of your father’s half will be set at $150,000 (half of the home’s value at his death), while the basis of your mother’s half will be $25,000 (half the purchase price and the couple’s presumed original tax basis). So if she sells the home for $300,000, she faces a taxable gain of $125,000 ($300,000 minus $175,000). Of course, she can then use her $125,000 exemption, assuming she is over age 55, to dispense of this obligation.

The same approach would apply to your parents’ stock holdings, and it works in reverse when assets depreciate in value. If the stocks were held as community property, their entire tax basis will be reset as of your father’s date of death. This means their depreciation cannot be treated as a tax write-off. However, if the shares were held in joint tenancy, just the 50% share owned by your father will be valued as of his date of death; the half owned by your mother will still carry their original tax basis, and upon their sale, presumably at a loss, she can write off the losses on her half as a capital loss.

The bottom line is that assets bequeathed at death carry a tax basis, for income tax purposes only, that is generally set as of the deceased’s date of death. In the case of joint tenancy, it is presumed that only the half held by the deceased is bequeathed, and only that half is revalued.

However, in an apparent effort by Congress to ease the financial burden on a surviving spouse, assets held as community property enjoy a significant exception to this approach. This benefit is perhaps the single largest reason why many couples hold their marital assets as community property in states, such as California, where it’s permitted.

However, holding marital assets as joint tenants allows the estate to avoid bankruptcy, the single largest reason why many couples elect to hold their assets this way.

In many cases, attorneys advise their clients to take advantage of the best of both types of vesting by appending a note to their wills explaining that their intention is for their possessions, no matter how registered, to be considered community property.

The following statement was drafted by Marvin Goodson of the Los Angeles law firm of Goodson & Wachtel to handle the matter:

“We hereby agree that all of the property we hold in joint tenancy is truly and completely community property, and we are holding it in joint tenancy for convenience only. We do not intend to change the character of the ownership of the property by holding it in joint tenancy.”

Goodson recommends that married couples sign and date the statement, preferably before a witness, and file it with their wills.

Little Recourse for Reducing Tax Impact

Q. I have a 401(k) account at work and want to use $30,000 from it to purchase a home. I am older than 59 1/2. What is the best way to minimize any tax impact?

--L.F.R.

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A. Outside of retiring, which could put you in a lower tax bracket, there is little you can do to reduce the amount of taxes you will owe on any withdrawal of funds that have yet to be taxed.

By virtue of your age, you will not face any early-withdrawal penalties. But remember, it is likely that the vast majority of your 401(k) account consists of money you set aside on a pretax basis, ostensibly for your retirement. This deal saved you taxes at the time you earned the money in exchange for your pledge to pay the taxes later, presumably when you weren’t working and were in a lower tax bracket.

However, if you also made after-tax contributions to your 401(k) account, withdrawals of those funds will not be subject to taxation, although the untaxed earnings that your savings generated while in the account will be taxed at withdrawal. The rules of your company’s plan will specify whether you can withdraw only the after-tax contributions; you may have to withdraw a mix of pretax and after-tax money.

Carla Lazzareschi cannot answer mail individually but will respond in this column to financial questions of general interest. Write to Money Talk, Business Section, Los Angeles Times, Times Mirror Square, Los Angeles, CA 90053. Or send e-mail to carla.lazzareschi@latimes.com