Tax Considerations of Joint Ownership

Tax Considerations of Joint Ownership

Every transfer of an asset has a potential tax consideration that must be considered. Many people approach estate planning with a simple solution. They place the name of a trusted adult child on their bank accounts or on the title to their homes. They do this to avoid probate or so 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, it is supposed that this child can be relied on to distribute cash and other assets to the other siblings fairly. Well, maybe! I can tell you it is not without it landmines.

California recognizes a number of different forms of property co-ownership, but the most common ways titled property is held are as tenants in common or as joint tenants. Both types of co-ownership have significant differences, both in the way they are created and the effect the death of one tenant has on the property as well as to the remaining tenants. Considerations of co-ownership typically revolve around planning for property distribution on death. For this reason, always seek the advice of an attorney before making a final decision. This does not address community property because that is held by a married couple and transfers between spouses are not subject to tax.

Tenants in Common: A tenancy in common is a form of property ownership that does not provide any survivorship rights among the co-owners, unlike with a joint tenancy. When one tenant in common dies, that tenant’s interest in the property does not automatically pass to the surviving tenants in common. Each tenant in common has the right to posses the entire property. In California, a tenancy in common is presumed, absent language to the contrary.

Joint Tenants: Like tenants in common, joint tenants have the right to possess the entire property. To hold title as joint tenants, the deed to the property must include the language “as joint tenants” or “as joint tenants with right of survivorship.” To create a joint tenancy, the joint tenants must have taken title to the property at the same time, they must have the right to possess the whole property, and they must have the same property interest. The key feature of the joint tenancy is the right to survivorship. Unlike a tenancy in common, when one joint tenant dies, that joint tenant’s interest automatically passes to the surviving joint tenants. This is true even if the decedent tenant’s will or trust provides otherwise. Often an heir who expects to get the property because it says so in the Will is stunned to find that it went to the Joint Tenant after all.

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: Gift taxes are payable for transfers of assets during life. The current amount you can transfer without filing a gift tax return is $13,000 per person and that person does not have to be related to you. Many people attempt to pass their assets on to 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 may be 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 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 even more complicated. Currently, the Federal Unified Credit allows the first $5 million of an estate can pass to heirs tax-free during one’s lifetime as gifts or as part of one’s estate at death. 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% for amounts over $5 million 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. This may be more relevant in 2013 where the gift tax rate may be reduced to $1,000,000.

Capital gains tax issues: A potentially more serious consequence is the adverse impact on “long term 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 an 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%.

The estate tax law provides a significant exemption in calculating capital gains on appreciated property which is part of an estate whether by will or trust. When one dies, one’s heirs receive a “step-up” in the basis of that property to the value of the property on the date of death — not on the date the property was acquired. How does this work? Mom buys a house for $50K and it is worth $500K when she dies leaving it to her children. The step up in basis would mean that the children get a new basis of $500,000 and, were they to sell it the next day, they would have zero capital gains.

When Mom adds the name of someone else to the title of her 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 Mom, 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 the same house bought by Mom for $50K that is worth $500K on her death. Because there is a joint tenant on the property, the survivor takes the basis of $50K and on selling it the next day for the FMV of $500K has a capital gain of $450K on which they pay 15% or $67,500 in tax.

Now assume a life time transfer of the home to Child: Often, child is so eager to get the gift of the home during life, the tax consequences are not considered until after. We are looking at the same $50K house that Mom gives Child. The Child takes the basis of $50K in the property. This is a gift so there is tax due on the transfer if the credit has not been used. Bigger than that unlikely tax, is the capital gains issue again. Child wants to sell the home and selling it the next day for the FMV of $500K has a capital gain of $450K on which they pay 15% or $67,500 in tax. Mom can die the next day and the step up in basis that would have been $450K is lost in the haste of a life time transfer.

One last aside here about adding a Child to your bank accounts: I just had a case where Dad added Child to his joint account. On Dad’s death, the account went, of course, to Child. Second Son was livid about this and litigated the matter and lost but ended up costing both of them more money than was in the account in the first place. If you add a Child to your accounts, understand and choose that it will go to that Child on your death OR write out your intentions, either in your Will, Trust or another writing. You might say, “I added Child to my account for convenience only and I intend that account to be used to pay for my expenses and then be divided by my children”. Whatever your intent, make it clear.

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