Using Joint Tenancies for Estate Planning
By Justin Fok, Esq.
What is Joint Tenancy?
Joint Tenancy is a legal way for people to own property together. The establishment of joint tenancy carries with it a “right of survivorship” meaning that when one of the joint tenants dies, the property passes to the other joint tenant(s) without having to go through probate. Joint tenancy is most commonly used as a way for couples to ensure that their property goes to their surviving spouse without the hassle associated with probate.
How is Joint Tenancy Most Commonly Used?
Joint tenancy is most commonly used in two ways to share the ownership of property:
1.Joint Tenancy Bank Accounts
Joint tenancy on a bank account is relatively easy to set up. Most banks have a standard joint tenancy account form, and all types of bank accounts may be owned in joint tenancy. When one of the joint tenants dies, the other joint tenant receives all the money in the account without going through probate. A joint tenancy account is not the best option, however, if the only purpose is to leave your money to another person. This is because creating a joint tenancy account gives the other person complete access to the money in the account right away. If it is your intention to leave your money to someone else on your death, you may consider a pay-on-death account instead.
Joint tenancy bank accounts can create a gift tax issue. There is no gift tax assessed simply by the creation of a joint bank account, however, the IRS considers a gift to be made if one of the joint tenants withdraws more than $12,000 over the amount that they put in.
This can be avoided by married couples by putting these funds into community property, as detailed below.
2.Joint Tenancy with Community Property
Community property is the property which a married couple or domestic partners agree to own together. By default, half of anything acquired during a marriage/domestic partnership, belongs to each spouse/domestic partner. This includes all real estate, stocks, income, etc. that couples purchase or gain during the marriage. The community property arrangement can be altered with a prenuptial agreement.
Under California law, community property held in joint tenancy (known as community property with right of survivorship) automatically passes to the surviving spouse upon one spouse’s death. This avoids probate, as well as estate taxes, and in some cases, capital gains taxes. This is discussed a little more in depth in the “stepped up” tax basis section below.
Tax Concerns with Joint Tenancy
There are some tax issues to consider when debating the use of joint tenancy.
The transfer of a property from a sole owner to a joint tenancy has the possibility of creating gift taxes. The annual federal gift tax exemption is $12,000 annually, per recipient. Therefore, if the property of a sole owner is converted into a joint tenancy and the value of the property is more than $24,000 (the value of half the property is $12,000), then the property would qualify as a taxable gift.
2.“Stepped Up” Tax Basis
In general, property inherited through joint tenancy receives an income tax break by being reassessed at its current market value. To understand this it is necessary to understand the “stepped-up basis” tax concept. If you were to buy a house for $100,000, that original purchase price would be your tax basis. If after twenty years, the house has a market value of $250,000 and you decide to sell it at that price, you would be charged a capital-gains tax on $150,000 (the selling price minus the original tax basis). This is how tax basis is established and calculated.
Under federal law, property must be stepped-up to the current market value upon the death of the owner. So in our example above, if you had inherited a house from your father which he had purchased for $100,000, the tax basis on the house would step-up to the current market value of $250,000. You could then sell the house for $250,000 without paying any capital gains tax. The entire $250,000 would enter your father’s estate for the purpose of estate taxes.
How does this relate to joint tenancy? In California this applies to married couples and unmarried joint tenants differently. For married couples whose joint tenancy property is also community property, the entire value of the property is stepped-up on the death of one of the joint tenants.
In a case of unmarried joint tenants, however, upon the death of one of the joint tenants, the entire property will be stepped up, except for any portion of the property that the surviving tenant(s) can prove they paid for. Proof of payment allows the surviving joint tenant avoid a large estate tax, in exchange for a smaller capital gains tax.
This is a very simplistic overview of the stepped up basis. When property which has the possibility to appreciate is owned by joint tenancy, there are many tax-related technicalities that can come into play. Therefore, it is best to speak with an attorney regarding this type of property to ensure that you have the most effective tax-avoidance system in place to protect as much of your estate as possible from state and federal taxes.
Is Joint Tenancy Right for me?
Joint tenancy is quite easy to create, and offers a solution for some people, but not all. Joint tenancy would most likely be the right choice for you in the following situations:
1.Buying a house
If you are considering buying a house with someone else (spouse, family, significant other) and want to ensure that your right in the property is transferred to the other person on your death, joint tenancy would be the simplest and easiest way to achieve this.
Joint tenancy can also be used as a last minute estate planning device. If the sole owner of a property has not done any previous estate planning, and is in poor health, transferring the property into joint tenancy is a quick and easy way to avoid having the property go through the probate process.
There are many instances, however, where joint tenancy is not the most advantageous choice. For example, once you transfer a solely owned property into joint tenancy, you can not convert it back without the other person’s consent. This can be a problem in relationships where the two parties no longer see eye-to-eye. Also, either joint tenant can sell their interest in the property at any time without the consent of the other joint tenant. Finally, creditors may attempt to collect debts based on either joint tenant’s interest in the property. While your property would remain safe, it may be necessary for you to sell the entire property to pay off the other tenant’s debts.
For questions on or comments regarding this article, please email Attorney Fok at: email@example.com