DANGERS OF JOINT TENANCY It seems that almost everyone places a great deal of property into joint tenancy without understanding either the nature or the consequences of doing so. Joint tenancy may be appropriate between a husband and wife if there is a properly drawn community property memorandum (see below). With rare exceptions, it is not appropriate between anyone else.
What is Joint Tenancy? The term comes to us from our English (common law) heritage. Each of the joint tenants is considered to own an undivided whole of the property. When one of the joint owners dies, the interest of that person terminates and the surviving joint tenants continue to own an undivided whole of the property.The typical situation is that of John and Mary Hubbard who are married with one child, Bill. John and Mary hold title to their residence as joint tenants. John dies. Mary now owns the home alone. It is her intention to live in the home until she dies, and pass it to their son. Mother Hubbard then places Bill on the title as a joint tenant. Assume the home is worth $100,000 at the time John dies, and the home has been paid off years ago.
Gift Taxes: The first danger is that when Mother Hubbard placed Bill on the title, she gave him a gift of ½ of the value of the home ($50,000). Mother Hubbard could transfer up to $10,000 per year to Bill and pay no gift tax. There is a gift tax liability on any gift which is more than $10,000 per year. When Mother Hubbard put Bill on title, she gave him a $50,000 gift, of which $10,000 was exempt. This means there is a gift tax liability on the remaining $40,000, and a gift tax return must be filed with the IRS. Many people have done this and failed to file a gift tax return. Such conduct is a mistake. The IRS can then collect not only the tax due, but also penalties and interest. Moreover, the statute of limitations does not start to run until the gift tax return is filed with the IRS.
Capital Gains Taxes: Capital gains taxes are a part of the income tax system, which is distinct from the estate and gift tax system. The problems here come from a concept called “basis”. We shall examine three examples using Father John, Mother Hubbard and son Bill (above). Example 1. John and Mary bought their home many years ago for $10,000. That is the “basis” for capital gain purposes. It is now worth $100,000. They decide to sell. The capital gain is computed by taking the market value ($100,000) and deducting the basis ($10,000), which gives us a capital gain of $90,000. (Do not be confused by their one-time exemption of $125,000, that is merely an exemption.) The capital gain which is subject to tax is $90,000. Example 2. John and Mary bought the house for $10,000 and took title as Joint Tenants. John dies. The basis is increased for the portion that John owned (which is one-half) from his $5,000 (his one-half of the original purchase) to $50,000 (his one-half of the market value at the time of his death). Mary's basis remains the same: $5,000. When we add John's basis of $50,000 to Mary's basis of $5,000, the total basis of $55,000 is determined. Mary decides to sell and move to a smaller place. The market price is $100,000 from which is deducted the basis of $55,000, and there is a capital gain of $45,000. The capital gain which is subject to tax is $45,000.Example 3. John and Mary bought the house for $10,000 and took title as community property. John dies. The entire basis is increased to the market value. In this case that is $100,000. Mary decides to sell and move to a smaller place. The market price is $100,000, from which is deducted the basis of $100,000, and there is no capital gain. The capital gain which is subject to tax is $0.Loss of the Asset: If the specter of unnecessary gift taxes and unnecessary capital gain taxes are not enough to consider, there is yet one more horror which must be examined: The loss of the asset. Again, we shall examine three examples to illustrate how serious this problem is. This is not theory, these are real life problems based on the John and Mary situation above.The situation now is that John has died. Mary has avoided probate by having the house in joint tenancy, and is not concerned about the tax problems. Her intent is to remain in the house until she dies, and have it pass on to son Billy Goat at her death. The vehicle she chooses to do this is to add son Billy Goat onto the title as a joint tenant with her. The title now reads: Mother Hubbard and Son Billy Goat, joint tenants. This means Son Billy Goat is a 50% owner.
Example 4. Son Billy Goat is a bum. A week or so after he was placed on the title he called Mother Hubbard from Las Vegas. "I was down on my luck, Mom, so I had to sell my half of the house to the casino." Can he do this? Yes. The house will be sold, Mother Hubbard will get her one-half, and be out looking for a new place to live. No nursery rhyme here!Example 5. Son Billy Goat is not a bum, he is merely inept. He invests all of his money and credit into his own new business. One year later, where is he? Bankrupt. The bankruptcy trustee is required to collect all assets, sell them, and place the money for the creditors. Can he do this? Yes. The house will be sold, Mother Hubbard will get her one-half, and be out looking for a new place to live, not even as nice as a cupboard. Example 6. Son Billy Goat is practically perfect in every way. One day he had to go to the hospital for emergency surgery. After he was discharged from the hospital (with bills totaling about $50,000) he discovered that his medical insurance had been canceled 4 days before he went into the hospital. Billy Goat had no way to pay this. The bill collector for the hospital and the physicians will be seeking all of Billy Goat's assets, including his interest in Mother Hubbard's house. Can he do this? Yes. The house will be sold, Mother Hubbard will get her one-half, and be out looking for a new place to live, perhaps even a shoe.The Best Way to Avoid the Joint Tenancy Problems is to Use a Living Trust: Of course, what all of this means is that joint tenancy usually creates more problems than it solves. It creates tax problems. It creates risks of losing the asset problems. If the result desired is to avoid probate, the only appropriate method to avoid probate is to use a Living Trust. Even for married people with a properly drawn community property agreement, joint tenancy avoids probate only for the first to die. When the Survivor dies, there will be a probate. If both die at the same time in a common accident, there is a probate.
The "bottom line” is that joint tenancy is not an appropriate way to avoid probate. The Living Trust provides all of the advantages of joint tenancy while having none of the disadvantages. When dealing with the assets you have accumulated during your lifetime, being penny wise and pound foolish' can have disastrous results. You have not spent all of your time and effort with the idea of losing your assets.
Joint Tenancy Creates More Problems Than It Solves.The living Trust is the cornerstone of a good estate plan. But there are other documents needed in order to complete the plan. There are five documents which need to be examined. We shall examine them individually, and point out one (the "living Will") which is commonly used but which is almost useless.