Problems with Joint Tenancy
A popular way two or more individuals hold title to their real estate or financial accounts is joint tenancy. This means that when one tenant dies, their interest in the property automatically gets transferred to the surviving tenant. A big reason people like to use joint tenancy is because it is a shortcut to avoid probate; however, they may not realize that this method of ownership can cause more problems than it fixes.
One significant downsides of joint tenancy for the reason of avoiding probate is that it takes away your flexibility as a property owner. Consider this: Once you sign the deed to real estate/property adding an owner, you can’t remove them without their signature. If you want to refinance or sell, you need the consent of the co-owner. Although joint tenancy might make property transfer easier when you die, it can create complications while you’re alive.
In most states, creditors of one joint tenant can reach the full value of the property, regardless of how much the person has paid into the property. Consider this scenario: You add your daughter as a joint tenant of your home because you want her to inherit it at your death and without probate. But what happens if she loses her job and can’t pay her bills? Or, if she gets into a car accident and is sued for more than her insurance policy covers? Regardless of whether or not it’s her fault, any bill your daughter can’t pay now may become your problem since she has become a part-owner of your home. In most states, her creditors can look to the full value of your home in order to collet what she owes them, despite you not having any involvement in any of her activities.
When you add someone to your real estate deed as a joint tenant, and that person doesn’t pay any money toward the value of the property, the IRS classifies the transaction as a gift. In most cases, this means that at the very least you would need to have the house formerly appraised and file a gift tax return, and depending on the circumstance, you might have to pay a gift tax.
When a parent gifts a child an interest in the house, the child takes the same basis as the parent. To many, this doesn’t seem to be a problem. However, consider this scenario: If parent bought the property for $100,000 and transferred 50% to daughter, at parent’s death, if the property had a fair market value of $1,000,000, only parent’s 50% interest would receive a stepped up basis; i.e. parent’s basis is $500,000 and daughter’s basis is $50,000. Therefore, if daughter sold the property at parent’s death, daughter would pay capital gains tax on her $450,000 in appreciation no capital gains tax on parent’s 50% interest.
However, if parent held 100% interest in the property until parent’s death, 100% of the property would get a stepped up basis; therefore, the basis in the property is $1,000,000. If daughter receives the property at parent’s death and sells the property for $1,000,000, daughter will not have to pay any capital gains tax.
Parents often unintentionally create family tension when they add their children as a joint tenant to their property. For example, if a parent has multiple children but only chooses one to serve as joint tenant, this means when the parent passes away, the asset in question belongs solely to that listed child. Regardless of whether or not the parent intended this, this unequal treatment can cause friction among siblings.
On the other hand, some parents will include all of their children as joint tenants. Unless they all get along and are extremely cooperative, the task of working together to manage a single asset as joint owners can cause a lot of conflict after the parents’ death.
Joint tenancy is only a temporary way to avoid probate. Eventually, the asset in question will need to be probated, or another estate planning tool will need to be used. When the last joint tenant dies, there will be ownership that needs to be transferred. At this point, title to the asset will transfer to the decedent’s heirs or beneficiaries through the probate process, unless other estate planning arrangements, like a living trust, have been made.
There are a number of estate planning tools that offer the benefit of avoiding probate, but without the drawbacks that joint tenancy has. An estate planning attorney can help you find a strategy that works best for you and your family. We invite you to call us at (650) 463-1550 to schedule an appointment with one of our attorneys!