Avoid the Pitfalls of Joint Property Ownership.

Many people approach estate planning with a simple solution.  They place the name of a trusted adult child on their bank accounts and sometimes even on the title to their homes.  They reason that if they become disabled this child will be able to pay their bills and otherwise conduct their personal business.  In the event of their death this child can be relied on to distribute cash and other assets to the other siblings fairly.  This approach to estate planning often leads to unpleasant unintended consequences and is usually not a good idea.

Types of joint property ownership

First, one needs to consider the various types of joint ownership (also called concurrent estate or co-tenancy).  There are three categories of joint ownership:

  • joint tenants with full rights of survivorship,
  • tenants in common,
  • tenants by the entireties. 

If one wishes to use joint ownership to pass property following death one must create a joint tenancy with rights of survivorship (JTROS or JTWROS).  Upon the death of one of the joint tenants the property automatically becomes the property of the surviving joint owner.  When two or more people own property as tenants in common the property does not automatically go to the surviving joint tenants on death.  Rather, the decedent's interest in the property goes to his or her estate.

Example: Sam and Susan own a bank account as joint tenants with full rights of survivorship.  Upon Sam's death the entire account becomes the property of Susan. There is a different result if Sam and Susan own the bank account as tenants in common.  Upon Sam's death his interest in the account would go to his estate and be distributed either by the terms of his Living Trust or as determined by the Probate Court.

Tenancy by the entirety is the property interest created when a husband and wife jointly owned property.  It is largely treated the same as joint tenants with full rights of survivorship.  The interest of the deceased spouse in any property automatically passes to the surviving spouse.

Potential tax problems

There are two potential tax problems that can be created when one tries to plan their estate with joint ownership.  These involve gift taxes and capital gains taxes.

Gift tax issues

Many people attempt to pass their assets onto loved ones through joint ownership.  This is usually done by putting one of their adult children's names on the title of all of their assets such as bank accounts, certificates of deposit, and the like.  There is an understanding with this child that he or she is to distribute an equal share of the account to their siblings upon the death of the parent.

Unfortunately, upon the parent's death this property legally becomes the full property of the surviving joint tenant.  While they may have the moral obligation to make distributions to their brothers and sisters they are under no legal obligation to do so. Any distributions to brothers and sisters will be fully voluntary and therefore a gift.  Gifts in excess of $13,000 a year are subject to gift taxes.

Here's where things get tricky.  The law provides two levels of exemptions for estate and gift taxes.  Typically, the first $5.2 million of an estate can pass to heirs tax-free.  Of this exemption up to $5.2 million can be passed to others during one's lifetime as gifts.  Distribution from the person that was the joint property owner to his or her brothers and sisters will either be subject to a tax of up to 45% or will have to be deducted from that person's estate and gift tax exemption.

In some instances the amounts in question are safely under these limits.  But, in other cases, this arrangement can provide significant adverse tax consequences to the child who was placed on the accounts as a joint owner.

Capital gains tax issues

A potentially more serious consequence is the adverse impact on capital gains.

Capital gains are taxes imposed on the appreciation of certain property that has been held for more than one year.  When one buys a so-called "capital-asset" their purchase price is that asset’s "basis."  If the asset is held for a year or more and then sold for a price higher than the basis the difference between the two is the "gain."  Capital gains are currently taxed at a rate of 15%.

Example: Sam buys 100 shares of stock in the Acme Corporation at $10 a share.  His basis is $1000.  Two years later Sam sells the stock for $50 a share realizing a gain of $4000.  That gain will be taxed at 15% creating a tax liability of $750.

The estate tax law provides a significant exemption in calculating capital gains on appreciated property which is part of an estate.  When one passes away their heirs received a "step-up" in their basis.  The tax basis for the heirs is the value of the property on the date of death -- not on the date the property was acquired.

Example: Sam buys 100 shares of stock in the Acme Corporation at $10 a share.  His basis is $1000.  Two years later Sam passes away and his heirs receive the stock through their Living Trust.  The value of the stock has gone up to $5000. The heirs' basis in the stock is $5,000, the value of the stock on the date of Sam's death.  If they sell the stock for $5,000 their capital gains tax liability will be zero.

When someone adds the name of someone else to the title of their property, creating joint property ownership, that person also receives the tax basis of that property.  When the surviving joint owner sells the property the tax treatment would be the same as if the property had been sold by the original owner.  The estate would lose its "step-up" in basis and be liable for the capital gains tax. This can this can be very costly.  Consider an example of real estate.

Example: mother purchased a residential home in 1971 for $50,000.  Over the next 38 years the value of the property appreciated to $150,000.  Upon mother's death the property is transferred to her heirs through a living trust.  The heirs receive a full step-up in basis and upon selling the house for $150,000 there is no capital gains tax.

However, had mother added the name of one of the children to the title of the real estate, that child would receive mother's original basis of $50,000.  The sale of the house for $150,000 would yield a taxable gain of $100,000 resulting in a net tax of $15,000.

While planning for the distribution of assets to joint tenancy seems simple, doing so needs to be considered very carefully.

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