What About Joint Tenancy?

What Is Joint Tenancy?

Joint Tenancy is a form of property ownership where, upon the death of one of the owners, all of the deceased owner’s interest in the property is transferred immediately to the surviving owners. Whether you realize it or not, if you are married, you probably own property in Joint Tenancy. Do you have a joint checking account? Then you probably own property in Joint Tenancy. Do you have a car or a home in both your and your spouse’s names? Then you probably own property in Joint Tenancy.

Although very common with married couples, many other people rely on Joint Tenancy. Friends, life partners, families, and many others own property this way.

Why is Joint Tenancy so common? Many people employ Joint Tenancy to avoid writing a Will and to avoid Probate. Joint Tenancy immediately passes full ownership of an asset to the surviving Joint Tenants. This is done by operation of law and avoids Probate and the need for a Will.

However, Joint Tenancy does not do so without the potential for problems. Let’s look at some of the problems associated with Joint Tenancy:

  • Joint Tenancy only avoids Probate at the first death. When the surviving Tenant dies, the estate will have to pass through Probate.
  • With Joint Tenancy, you lose control of how your assets will be distributed upon your death.
  • The $5.49 million federal estate tax exclusion is forfeited if the assets go to your spouse.
  • In some states, Joint Tenancy will expose your assets to capital gains taxes that could have been avoided.
  • If Joint Tenants are not married, gift taxes may be due.
  • Joint Tenancy exposes all Tenants to the financial liabilities and creditors of all the other Tenants.

Let’s take a closer look at some of these problems and how they may affect you.

Control Goes to the Surviving Joint Tenant

One reason people write a Will or establish a Trust is to determine how their assets will be distributed upon their death. If you have spent your whole life earning money, you probably have some idea as to how you would like to see those assets used and by whom. With Joint Tenancy, you give up the right to make those decisions.

Assume for a moment that you have remarried and have children from your previous marriage. If you have Joint Tenancy with your new spouse, your children essentially have become disinherited. You would like to believe you can trust your new spouse to take care of your children, but once you are gone, you have lost the ability to make sure it happens.

Let’s look at another scenario. Imagine for a moment that you have died and your widow/widower has remarried. Upon your spouse’s death, his or her new spouse could get all of the assets from your estate instead of those assets going to your children or grandchildren, or any of your relatives for that matter.

Loss of Federal Estate Tax Exclusion

The federal government allows individuals to pass up to $5.49 million of their assets estate tax-free in 2017. Married couples have the opportunity, with correct estate planning, to each get the exclusion for a total of $10.98 million in 2017. With Joint Tenancy, the death of one spouse means immediate loss of their tax exclusion. This typically does not affect the surviving spouse due to the marital deduction that allows spouses to pass unlimited assets to one another at death without incurring any estate taxes. The problem arises, however, upon the death of the second spouse when the estate taxes are due on twice the property that would otherwise be taxable.

The problem is even greater when non-spouses hold property in Joint Tenancy. When the first person of the Joint Tenancy dies, the entire value of the asset is included in his or her estate, unless the surviving Joint Tenants actually paid for their interests. This means that if you owned a vacation home with your child that was worth $2.5 million, the entire amount of $2.5 million would be included as part of your net estate. This means that the taxes for this estate must be paid for the entire amount even though the asset now belongs to your child!

Community Property States and Capital Gains

Couples who live in or own real property in one of the nine community property states — Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington and Wisconsin — pay a high price in capital gains taxes when using Joint Tenancy instead of Community Property.

The capital gains tax is a tax levied on your profit when you sell an asset. To determine the amount of capital gains you deduct your investment from the selling amount of the asset. This difference equals your capital gains and is the amount used to compute your tax. For instance, if you buy a home at $100,000 and sell it at $150,000, the capital gain is $150,000 minus $100,000, which equals $50,000. You would owe taxes on $50,000 of capital gains.

The federal government provides a capital gains tax break on assets in a person’s estate. Called a step-up in basis, it simply means that when you die, the government will consider your heir’s cost basis in an asset to be its current market value, not your original purchase price. So, if the property you originally bought for $100,000 is worth $150,000 when you die, your heir’s cost basis would be $150,000. If your heir sells it for that price, no capital gains tax will be due. If they sell it later for $250,000, instead of owing $250,000 minus your original purchase price for a tax gain of $150,000, they would only owe $250,000 minus their cost basis of $150,000 for a tax gain of $100,000.

In a community property state, if you hold title to an asset in Joint Tenancy with your spouse rather than community property, you do not get the same step-up in basis. Instead, you only get the step-up in basis on your half of the property. If you held the property in community property, you would get a step-up on both halves of the property.

For example, let’s assume you and your spouse buy some land for $100,000 ($50,000 each) that increases to $300,000 ($150,000 each) by your death. Whether you own the property in Community Property or in Joint Tenancy, your half of the property will get a step-up in basis from $50,000 to $150,000. If you held it as Joint Tenancy, your spouse’s half would not get a step-up in basis at your death, resulting in a total basis of $150,000 (your half) plus $50,000 (spouse’s half), for a total of $200,000. However, if you used Community Property rather than Joint Tenancy, your spouse’s half also would have received a step-up in basis, resulting in a basis of $150,000 (your half) plus $150,000 (spouse’s half), for a total of $300,000.

Gift Taxes and Joint Tenancy

When you own property using Joint Tenancy with someone other than your spouse, the government may see this transaction as a gift instead of estate planning. If this happens, gift taxes will become due, and you will typically be liable for the taxes. The amount of the gift tax depends upon the asset.

Gift taxes on real estate are much worse than with a bank account. Cash in a bank account is only considered a gift when it is used. Real estate, on the other hand, is considered a gift as soon as the Joint Tenancy is created.

Of course, there are some exemptions available for gifts.  Each year you may give away up to $14,000, indexed for inflation, per individual — and to as many individuals as you want — with no gift taxes due. Gifts in excess of that $14,000 are applied to a lifetime exclusion of $5.49 million for gifts, which reduces the $5.49 million applicable exclusion available to cover transfers at your death. Even if your gift falls within the exclusions described above, you must still report it on your federal gift tax returns.

Joint Tenants and Financial Risk

When you own property with a Joint Tenant, each of you owns half of the asset. The other half is controlled by the other Joint Tenant. This means that you could lose the value of half your asset if the other Joint Tenant goes bankrupt, owes taxes, gets divorced, or has lawsuits filed against them. In these cases, you may have to sell the asset to pay off the other Joint Tenant’s bills.

There Are Alternatives to Joint Tenancy

Instead of Joint Tenancy, you can use the following alternatives:

  • Own property solely in your own name.
  • Own property as tenants in common.
  • If you live in a community property state and the property is held with your spouse, you can elect that ownership option.
  • If you live in a “tenancy by the entirety state” and the property is held with your spouse, you can elect that ownership option.

Most often, however, the best way to obtain the objectives you were seeking through Joint Tenancy is to establish a Revocable Living Trust.

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