Estate Planning Defined – What are the “Pros” and “Cons” of “Transmuting” Property Owned by a Married Couple in California?

James B. Creighton | December 14, 2010 | 2 Comments

Issue: Married couples who reside in California have the opportunity to accumulate community property, separate property, quasi-community property, or some combination of the three. Sometimes a married person may wish to convert his or her separate property to the community property of the married couple or even to the separate property of the other spouse. Such a conversion of one spouse’s separate property to the community property of the couple or the separate property of the other spouse is known as a TRANSMUTATION of the character of the property, i.e., transmutation is the process by which the property rights of married persons are changed.

If either or both spouses intend(s) to transmute the character of property that either or both of them own(s), it is advisable that they do so via a written agreement. Such agreements are used for a variety of estate planning purposes. For example, it may be desirable in a long-term marriage to convert the property that a wife inherited from her family to the community property of the wife and her husband to achieve a “stepped-up” basis in the property at the time the first of the spouses dies. (“Basis” means the “starting value,” or what you paid for the property, when calculating the gain from a sale of property. For example, if you pay $250,000 for a piece of real property that you later sell, your “basis” in the property, for purposes of calculating the gain on the later sale, is $250,000. A “stepped-up” basis means an increase in that “starting value,” which will ultimately reduce the amount of capital gains tax that will be owed when the property is eventually sold.) By converting property in this manner, the married couple and their beneficiaries avoid unnecessary capital gains upon the spouses’ respective deaths by receiving a double step-up in the basis (on both halves) of their newly created community property; one step-up in basis on the entire property occurs upon the death of the first spouse and another step-up in basis on the entire property occurs upon the death of the second spouse. (By contrast, property held in joint tenancy receives only a step-up in basis on the one-half of the property that was owned by the first spouse to die; the basis in the property owned by the surviving spouse is NOTstepped-up.”) Below, I discuss some of the primary advantages and disadvantages of transmuting one’s property.

Advantages of Transmutation. Let say, for example, that Gwen has a much larger estate than her husband, Chris. In the estate planning context, it might be advisable for Gwen to transmute some of her separate property to Chris’ separate property (i.e., to give Chris some of her separate property), so that Chris can take full advantage of the federal estate tax exemption known as the applicable exclusion amount. The applicable exclusion amount is the amount of property that a person can transfer at his or her death free of federal estate tax. If the cumulative value of Chris’ estate is less than the applicable exclusion amount, then Gwen might consider transmuting some of her separate property to Chris’ separate property, thereby increasing the size of Chris’ estate. Then, when Chris dies, his estate can more fully use this important federal estate tax exemption, which would result in an overall reduction in estate taxes on the couple’s family (because Chris has maximized the size of his estate, while not exceeding the applicable exclusion amount, and Gwen has minimized the amount by which her estate exceeds the applicable exclusion amount by giving Chris some of her property).

In other situations, it may be necessary to transmute property so that the actual ownership of the property reflects the couple’s intentions. For example, if both spouses agreed that one of them should take legal title to real property in his/her name alone to more easily complete the financing of the property, but their ultimate intent was that both of them own the property as community property, then the spouses must remember to transmute the property from the one spouse who took legal title alone to both spouses as their community property. In the case, Marriage of Brooks and Robinson (2008) 169 CA4th 176, 86 CR3d 624, the real estate agent recommended that just the wife take legal title to the couple’s residence because this would make it easier to borrow against the property (i.e., take out a mortgage on the property). The husband agreed, and the wife took legal title to the home in her name alone, as her separate property. The couple used the husband’s earnings from his employment for the down payment. In addition, the husband made payments on the mortgages that were secured by two deeds of trust. Unfortunately, the couple decided to divorce and the true ownership of their home became a matter of dispute. The court held that since the wife had the husband’s consent to take legal title to the family home in her name alone, the home was NOT the community property of both spouses, but instead was presumed to be the wife’s separate property. Although the court explained that this presumption could be overcome by clear and convincing evidence that the legal title on the deed was not the couple’s intent, unfortunately for the husband, the facts that the legal title to the home was taken in this manner to facilitate financing and that the down payment and subsequent payments on the mortgages were traceable to the husband’s community property earnings were not sufficient to overcome the presumption that legal title was conclusive as to ownership of the property. The court concluded that the home was the wife’s separate property. Now, few, if any, married couples would expect that following the advice of a real estate agent that one spouse take legal title to the property to make financing the property easier would result in a court deciding that the spouse on title is the sole owner of the property. How could the couple have avoided this result? They could have avoided this result by signing a Transmutation Agreement that clearly explained their intentions. Such an agreement would have provided the clear and convincing evidence that was needed to overcome the title presumption so that both spouses would have owned their home as they intended, i.e., as their community property.

Disadvantages of Transmutation. In harmonious and fully functional families, transmutations of property can achieve a number of estate and tax planning advantages for the spouses and their intended beneficiaries (e.g., their children).

However, anyone who is thinking of transmuting his or her real property or substantial personal property should always seek legal assistance before doing so. Not to do so would invite peril. For example, let’s say Margaret’s husband, Tom, used $170,000 of his separate property cash to purchase 2,000 shares of Google stock at $85 per share when it went public in August 2004. The shares of stock were then deposited into a newly opened Charles Schwab account and the title to the account read, Margaret and Tom, Joint Tenants With Right of Survivorship (JTWROS). By taking title to the brokerage account in this way, Tom made a gift of $85,000 of his separate property cash to Margaret (as her separate property), which she then used to purchase 1,000 shares of Google stock. Right? It certainly looks that way. However, the couple did not want to pay an attorney to draft a transmutation agreement and they certainly didn’t want to pay two more attorneys to review the agreement with them. So, neither Margaret nor Tom signed such an agreement.

Now, over six years later, Margaret and Tom are getting divorced, due to irreconcilable differences. The Google stock is trading at $595.00 per share, meaning that the initial $170,000 investment is now worth $1,190,000! And, guess what? Tom claims that he never intended to make any gift of his cash to Margaret. He claims that he put her on title to the Schwab account for convenience only—in case something happened to him and she needed to access the account—and not because he intended her to own half of the Google stock in the account. Of course, Margaret argues that Tom clearly intended to transmute $85,000 of his separate property cash Margaret’s separate property.

Could this disaster have been avoided?
YES! The better course of action would have been for Tom and Margaret to have entered into a written transmutation agreement. Clearly, in this case, the cost of assistance from attorneys would have easily been outweighed by the value of the stock Tom and Margaret are fighting over.

Can a couple transmute property solely for estate planning purposes and not for marital dissolution purposes?
NO! Courts in two important cases have held that a transmutation agreement made for estate planning purposes is also valid and must be used for purposes of divorce as well. See Marriage of Holtemann (2008) 166 CA4th 1166, 83 CR3d 385 and Marriage of Lund (2009) 174 CA4th 40, 94 CR3d 84. In short, there is no such thing as a transmutation of property only for estate planning purposes.

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Disclaimer: Please note that the information in this blog post does not constitute legal advice, and should not be relied on, since each state has different laws, each situation is fact-specific, and it is impossible to evaluate a legal problem without a comprehensive consultation and review of all the facts and documents at issue. Finally, the information provided to you in this blog post does not create an attorney-client relationship.

Notwithstanding the disclaimer, I hope this information has been helpful. Please leave a comment about this post if you have the time. Thank you. James B. Creighton, Esq., Creighton Law Offices

Related posts:

  1. Estate Planning Defined – What Is Community Property?
  2. Estate Planning Defined – What Is an “Estate Plan”? (Part 3 of 3)
  3. Estate Planning Defined – What Is an “Estate Plan”? (Part 1 of 3)

Comments

  1. This post is very good. I’ll put a link up to it on my site.

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