Hello. My name is Kyle Krasa and I’m an estate planning attorney in Pacific Grove, California. I’m certified by the state bar of California, as a legal specialist in estate planning trust and probate law. The purpose of this video is to give you general information about an important aspect of estate planning law so that you can be prepared when working with your own attorney. Watching this video does not establish an attorney client relationship. The law is far more complex and nuanced than can be explained in a few short minutes. As a result, before acting on any of the information contained in this video, you should consult a competent attorney who is licensed to practice law in your community. With that understanding, I hope you enjoy my video and you find it informative. Thank you.
Capital gains tax is a special type of income tax that applies to certain investment properties such as stocks, real property and collectibles like artwork and that kind of thing. Let’s take stock for example. Let’s say that you purchase stock for a dollar a share. That’s what you paid for the stock because that was what it was worth when you bought it. That is known as your basis. Your basis is a dollar a share. Let’s say that you’ve hung onto that stock for a while. You did really well in the stock market and now that stock is worth $3 a share, so that’s the current fair market value. All right? Now let’s assume that you decided to sell that stock. Hey, you know the value has gone up. I think now is a good time to sell. So you sell that stock, you bought it for a dollar a share, you sell it for $3 a share.
Well, the IRS is going to say that you had a capital gain of $2 per share, right? You bought it for a dollar a share. It’s worth $3 now. So you had a $2 per share gain and they’re going to tax you at the capital gains tax rate on that $2 gain. So the combined California and federal capital gains tax is approximately 30% it does depend upon your tax bracket. It could be a little lower, it could be a little higher. But general rule of thumb, if we’re going to combine California and federal capital gains tax, it’s going to be around 30% so that would mean 30% of $2 per share is going to be your capital gains tax and you’re going to owe that come April 15th now let’s assume that you bought the stock for a dollar a share and you gave it away while you were still living.
So instead of selling it, you decided to give it away to a friend, to a family member, to a child. Doesn’t matter who the person is, you just gave it away. Well, if you make a lifetime gift of that capital gains property, the person who receives the property from you is going to inherit your basis. So if they decide to sell that stock, they’re going to have the same consequence. If your basis was a dollar a share and you give it away and they sell it for $3 a share, they’re going to have a $2 per share capital gains tax. Now let’s assume that instead of giving it away while you’re living, you decide to leave it to someone in your trust or in your will so it doesn’t transfer to your beneficiary until you pass away. Well, what the IRS says in that case, if you hang on to that stock and you have it at death, then your basis will get readjusted to the fair market value on your date of death.
So if you bought that stock for a dollar a share and it’s worth $3 upon your death, your beneficiary, the person who inherits this stock from you, their basis will actually be $3 a share. It will be the value as of your date of death. It’s not going to be your original basis. So that basis gets readjusted to the fair market value on the date of death. And if that beneficiary decides to sell that stock for $3 a share, that beneficiary is going to have zero gain. And the reason is because their new starting point is whatever the date of death value was, and they’ve said they sell that stock for the same value as it was worth on your day to death, they have no gain at all. If they hang onto the stock and they keep it for a year or two and the stock is now worth $4 a share and they decide to sell it, they’re only gonna have $1 gain because their starting point for determining gain is not what your original basis was.
But it’s what the fair market value was on the date of death. So this concept of a basis adjustment to the fair market value on the date of death can be an extremely valuable benefit to your beneficiary. It’s often referred to as a step up in basis. Now it’s important to understand that this is not always a step up. Sometimes it could be a step down. So, in other words, if the stock, if you purchase a stock for a dollar a share, but upon your death, instead of it being worth $3 a share, it was only worth 50 cents a share, that basis is going to go down. It’s going to readjust it to the value on your day to death. And that might not necessarily be a good thing for your beneficiary. The reason why this concept of step up and basis is used so much is because hopefully most assets will appreciate over time and it’s when the basis goes up rather than down.
That’s when you really, your beneficiary really has a significant tax advantage. So we’ll use the term step up in basis, but you should keep in mind that it’s, what’s the true rule is isn’t the basis adjustment to the fair market value on your date of death. Now, um, this, this general concept does apply to other things like real property and investment assets. There are a lot of nuances and exceptions when it comes to real property. For example, if you put money into the real property that’s going to increase your basis and thereby decrease the capital gain that you’re going to have to pay. If it’s your residence and you, you sell that residence, then the first $250,000 of capital gain will be excluded. So there are some exceptions, but the same general rule applies. Okay, so this concept will apply in all 50 States. This basis adjustment to the fair market value upon your date of death.
What’s different in the nine community property States of which California is one of them is what happens when a married couple owns capital gains property together. Now in California, the two main ways that a married couple can own property together are joint tenancy, which is available in all 50 States. Between spouses. That’s going to be a 50/50 type of ownership. And then in the nine community property States, a married couple can also hold title as a community property, which is also a 50/50 type of ownership. Now, the way the IRS interprets joint tenancy is if one spouse passes away, that spouses share will get a step up in basis and that makes sense. They pass away. There should be a basis adjustment to the fair market value as of the date of death. Hopefully it’s a step up and not a step down.
Now the surviving spouse, his share is not going to get a basis adjustment and that makes sense because the surviving spouse is still living, so if the surviving spouse decides to sell appreciated capital gains assets like stock or real property or collectibles, then the surviving spouse will have to pay capital gains tax on their half. They won’t have to pay it on the decedent’s half or not as much on the decedent’s half, but they will have to pay capital gains tax on their half. The way the IRS views community property though is with one spouse dies. Not only is the deceased spouse’s share going to step up in basis, but so does the surviving spouse’s share. That also gets a step up in basis. This is often referred to as a double step up in basis and this is a huge advantage to the surviving spouse. If the surviving spouse wants to sell that appreciated, um, real property or appreciated stock or appreciated artwork, they can sell it and they won’t have to recognize any gain at all where they’ll just have to go back to whatever it was worth on the first spouse’s date of death, even for their own half.
So this is a huge advantage for taxpayers in the nine community property States. And if you are a married couple and you live in one of the nine community property states, it’s something worth considering. A lot of times joint tenancy is going to be the standard way to hold title. The reason for that is because most of the financial firms are based on the East coast where joint tenancy is very common where community property doesn’t exist. Um, also because it’s just, it’s available in all 50 States. So that’s kind of a default. But everyone kind of tucks you into and so a lot of your assets, you might not even realize it, but they might be held in joint tenancy without even your knowledge. So one thing, a married couple and a community property state like California should consider doing is signing a property agreement that converts all joint tenancy property into community property. So that way the surviving spouse can get the double step up in basis.
I hope you enjoyed watching my video. As I mentioned at the beginning, this is not intended to be a substitute for proper legal counsel. Before acting on any of the information contained in this video, you should consult a competent attorney who is licensed to practice law in your community. Thank you.