New kid on the title block. (Estate Planning).

A new title option for married couples, known as community property with right of survivorship (CPWROS), is intended as a "best of both worlds" hybrid between community property titling (CP) and joint tenancy with right of survivorship (JTWROS). CPWROS was created so a married couple could avoid probate on jointly held assets and to achieve the same basis benefits as traditional community property.

But does this new title deliver what it promises? The answer may be less obvious than practitioners and clients would like.

A GOOD THEORY

CPWROS sounds like a great solution to a common problem. California couples shun community property titling to avoid probate. But by opting for JTWROS they lose the advantages of CF titling. Under IRC Sec. 1014(b)(1) and (6), community property titling allows the survivor to claim a fair-market value date of death basis for the decedent's half interest and the surviving spouse's half interest. In other words, CP titling provides the survivor a new fair-market value date of death basis for the entire property.

By contrast, joint tenancy provides the surviving joint tenant with a date of death value basis only for the decedent's half interest in the jointly owned property.

One solution to this dilemma has been for couples to take title as joint tenants with right of survivorship, but then have an acknowledgment--usually inside a trust or will--stating their intention that the property remain a community" asset, regardless of the form of title.

The IRS approved such arrangements in Rev. Rul. 87-98, confirming that property that is OP for purposes of state law qualifies for community property's two-part basis step-up (the decedent's and the survivor's interests), even though it's held in a common law estate like joint tenancy.

Community property with right of survivorship would seem like a way for married couples to ensure an easy transfer to the surviving spouse at death without probate. And since assets are a type of community property, the surviving spouse should be able to claim a date-of-death basis step-up for both interests.

Or so the argument goes.

THE MYSTERY BEGINS

Our puzzle begins with the threshold issue of estate includibility. For both JTWROS and the non-survivorship version of community property, the basis step-ups allowed under IRC Sec. 1014(b)(1) and (6) have one important condition: the decedent's half interest must be includible in his gross estate. And for both JTWROS and traditional community property, the code is clear: Sec. 2033 and 2040 require estate includibility for the decedent's interest.

But what about CPWROS? Well, that's where it gets muddy.

Some have argued that the otherwise attractive survivorship feature of CPWROS also prevents estate inclusion, since the deceased spouse's interest is automatically extinguished at death.

And (unlike JTWROS) there is no IRC provision to sweep the decedent's interest back into the estate fold. Yet without estate includibility, the argument goes, neither half of the property is entitled to a basis step-up. (See Virginia Tax Review 577 Winter 1998).

And what about Rev. Rul. 87-98? It may be dangerous to presume comfort beyond its particular facts. CPWROS and JTWROS may share a survivorship feature, but CPRWOS lacks a clear argument for estate includibility, so the allowable basis adjustment--if any--is dubious.

Good as the concept may have sounded to California legislators, CPWROS titling appears to have created a degree of unanticipated tax risk.

For couples whose principal residence is below the $500,000 capital gain exclusion, or in situations where basis is not an issue, this potential downside to CPWROS evaporates.

Aggressive practitioners also realize that basis is a self-reported item. The only way to verify it would be through an audit--a small risk, but one with potential repercussions, including interest and penalties.

Were the issue ever litigated, Rev. Rul. 87-98 might well be extended by analogy to justify a basis step-up for both half-interests to fair-market value upon the first death. That's the result the Legislature had in mind when it adopted CFWROS. But the state Legislature's good intentions are not binding on the IRS.

Until clarification comes from the IRS, titling property JTWROS along with a side agreement that property is held as community property--an approach which has the support of Rev. Rul. 87-98--looks like the safer way to go.

Titling Basics

                       FMV/date of death
Title Form             Basis Adjustment *

Joint Tenancy **       Decedent's interest
                       [IRC 1014(a)(1)]

Traditional Community  100% step-up on first death
Property               [IRC 1014(b)(1)&(6)]

CPWROS                 Undetermined



Title Form             Passes on Death

Joint Tenancy **       Automatically to survivor
                       (No probate)

Traditional Community  One-half devisable;
Property               Requires probate to transfer

CPWROS                 Automatic transfer to survivor
                        spouse (No probate)

* While normally we think of this basis adjustment as a "step-up," an
adjustment to fair-market value at date of death can also operate as a
"step-down" in periods of declining asset values.

** Unlike community property forms of title, joint tennacy interests can
be held by more than two people, as long as the shares are equal, and
co-owners need not be married.

Robert Leonard, Esq., CPA, specializes in tax controversy and tax collection matters. You can reach him at [e-mail].