Tax Implications of Adding Spouse to Deed

Adding a spouse to a property deed is a common decision for married couples, often done to ensure rights of survivorship and simplify asset management. While the process may seem straightforward, it carries several tax consequences that homeowners should evaluate beforehand.

Immediate Gift Tax Considerations

When an owner adds a spouse to a property’s deed, the law views it as a gift of one-half of the property’s fair market value. Normally, gifts exceeding the annual exclusion amount—$18,000 for 2024—would require the donor to file a federal gift tax return, Form 709. This reporting is required even if no tax is immediately due because the amount counts against a person’s lifetime gift and estate tax exemption. However, for transfers between spouses who are both U.S. citizens, the unlimited marital deduction simplifies the situation. This provision allows individuals to transfer any amount of assets to their spouse without incurring federal gift or estate tax, meaning Form 709 is not needed.

Impact on the Property’s Cost Basis

A property’s cost basis is its original purchase price, plus the cost of any significant improvements made over time, less any depreciation claimed. When a spouse is added to a deed through a gift, they do not establish a new basis. Instead, the “carryover basis” rule applies, meaning the new joint owner assumes the original owner’s basis for their share of the property.

For example, if a person bought a home for $400,000, this amount is their initial cost basis. If they later add their spouse to the deed, making them a 50% owner, the spouse’s basis in their half of the property is $200,000. The original owner’s basis in their remaining half is also $200,000, keeping the total basis for the couple at the original $400,000.

Capital Gains Tax When Selling the Home

Adding a spouse to a deed can be advantageous due to the home sale exclusion under Internal Revenue Code Section 121. This rule allows homeowners to exclude a substantial amount of profit from capital gains tax when they sell their primary residence. For a single individual, the maximum exclusion is $250,000, while a married couple filing a joint tax return can potentially double this exclusion to $500,000.

To qualify for the full $500,000 exclusion, certain tests must be met. Both spouses must meet the “use test,” meaning they both have lived in the home as their primary residence for at least two of the five years preceding the sale. However, only one spouse needs to meet the “ownership test,” having owned the property for at least two of the five years.

If a couple sells their home for $1 million and their original cost basis was $450,000, their capital gain is $550,000. A single owner would be able to exclude $250,000, leaving $300,000 of the gain subject to capital gains tax. A married couple qualifying for the full exclusion could shield $500,000 of the gain, resulting in only $50,000 being taxable.

Tax Consequences Upon the Death of a Spouse

The tax implications following the death of a spouse are complex and depend on state law and how the property is titled. A central concept is the “step-up in basis,” which adjusts the property’s cost basis to its fair market value on the date of the spouse’s death. This adjustment can significantly reduce the capital gains tax the surviving spouse might owe on a future sale, but its application varies between common law and community property states.

In most states, which follow common law, property owned by a married couple is often held in joint tenancy. In this scenario, only the deceased spouse’s portion of the property receives a step-up in basis, while the surviving spouse’s original basis for their share remains unchanged. For instance, if a couple bought a home for $200,000 and it is worth $800,000 when one spouse dies, the deceased’s 50% interest gets stepped up to $400,000. The survivor’s original basis for their half remains $100,000, resulting in a new total basis of $500,000.

A handful of states follow community property laws, where property acquired during the marriage is generally considered owned equally by both spouses. Upon the death of one spouse, the entire value of the community property is stepped up to the fair market value at the date of death. Using the same example, if the $200,000 home is now worth $800,000, the entire basis for the surviving spouse becomes $800,000, which can eliminate the capital gain if the home is sold.