Three Reasons Why Joint Tenancy is Not an Alternative to a Trust

Holding assets as joint tenants (or tenants by the entirety) is not an alternative to establishing a living trust. If your only concern is making sure your spouse is able to inherit your assets without issue, joint tenancy may work. However, if you are like most people and are concerned about your children or other heirs inheriting your property, joint tenancy is likely not a good idea. There are three things you should understand about joint tenancy.

Joint Tenancy and Ownership

First, when you name someone as a joint tenant they own the property. They are not just designated beneficiaries after you die, they are joint owners. If you and your spouse are joint tenants this will likely not be an issue, but if your thought is you can add your two children on as joint tenants, it might. In that case if you, your spouse, and your two children own one property, your children actually own half of your house. They can use it, change it, sell it, or even ask a judge to portion it in kind (i.e. by selling the whole house and giving them half of the proceeds).

Even if you completely trust your children, this notion might be a bit disconcerting. It also means that your children's share of the house would be attachable by their creditors. This means that while you may start out with your kids as joint tenants, you may end up with a bank as your joint tenant.

Joint Tenancy and Gift Taxes

Second, if you name someone other than you’re spouse as a joint tenant you are making a taxable gift assuming it does not qualify for the $14,000 annual exclusion. Every American has a $5,000,000 lifetime applicable exclusion, indexed for the effects of inflation from 2011 ($5,490,000 in 2017).

This means that if you and your spouse each make gifts of one quarter of the house to your two children, the value of the house would have to be over $22 million in order for there to actually be taxes imposed, assuming you have not previously filed a gift tax return. However, even if no gift tax is owed, you will still have to file a gift tax return, if under the same scenario, the value of the house exceeds $112,000. Gift tax returns are not commonly filed and most accountants charge a few hundred dollars for one.

Getting a Step-Up in Basis

Third, if you use joint tenancy with someone other than your spouse, they will not get a step up in basis on part of the property at your death.

If you are married and both own an appreciated asset as community property, your surviving spouse will receive a step-up. This is a step-up in the cost basis to the fair market value (taken at the date of death of the deceased spouse).

The easiest way to see this is through an example.

Imagine that you bought a house right now for $100,000 and by the time you die, it is worth $500,000. If you give the entire house to your kids now, because it is a lifetime gift, they will take your basis and their basis will be $100,000. If they sell it when you die, they owe taxes on the sale price minus the basis, in this case on $400,000.

However, if they inherited the property, they would get a step up in basis to fair market value. In that case, they would pay taxes on the fair market value minus the fair market value at your death, essentially nothing if they sold the home immediately. The tax on $400,000 is substantial and a big reason why you may want your heirs to inherit property at your death rather than during life.

With joint tenancy, if you and your spouse name your two kids as joint tenants, you have gifted half of your house. The IRS will thus give you a basis step-up on half of the value, but not the other half. This would mean that in our example before, your children's new basis would be $300,000, not as bad a the $100,000, but not as good as the $500,000. That should be a major disincentive to using joint tenancy property.

In sum, between someone else owning your house, having to file a gift tax return, and not fully getting a step-up in basis, it should be clear that joint tenancy is not a good alternative to creating a living trust.

Learn more about how the estate planning attorneys at Cali law can assist you today.

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