For any number of reasons, you have decided to add a partner, child, or close friend as a joint owner on one or more of your assets. Perhaps you are concerned about becoming disabled, and want to know that your loved one can easily pay your bills and manage things for you. Perhaps you want to ensure that when you pass away your partner will inherit the home you share without having to go through the hassle of opening and administering an estate. What’s not to like about such an easy plan?
Well, unfortunately – a lot. That’s because joint ownership can produce some nasty tax and other consequences.
Benefits of Joint Ownership. The typical form of shared ownership between unmarried individuals such as domestic partners, parents and children, and siblings is “joint tenants with rights of survivorship,” often abbreviated as “JTWROS.” With this arrangement, each owner can access and manage the property, and if one owner dies, the property passes automatically to the surviving owners in a simple and efficient manner.
Problems with Joint Ownership. However, there are a number of significant consequences to adding a joint owner to your assets. Here are just a few:
You’ve Exposed your Asset to New Creditors. When you add an individual as a joint owner to your property, you are exposing your property to their creditors. Want to add your son to your bank accounts so he can pay your bills? If he has creditor problems, gets divorced, files bankruptcy, or gets into a car accident, those creditors can come after his ownership interest in your nest egg. Same thing if you add his name to the Deed for your house.
You’ve Made a Gift to the Joint Owner. When you add a joint owner to your assets, you are making a gift to that individual of one-half of the asset (if you add two owners, you’re making a gift of a third to each, four owners, a gift of a fourth, etc.) And, if you give more than $14,000 to an individual in any given year (easy to do if you’re giving them an interest in your house), then you are required to report those gifts to the IRS on a gift tax return (Form 709) and pay any gift tax that might be due
You’ve Forfeited an Important Tax Benefit. When you die owning appreciated property, your heirs receive one of the most important benefits in the whole tax code, called a “stepped up basis” in the property. This stepped up basis can eliminate some or all of the capital gains tax that could be due if the property is sold when it is worth more than what you originally paid for it. For example, if you bought your house for $150,000 and it is worth $250,000 when you die, then your children will inherit the property from you at its “stepped up” basis ($250,000, the value on your date of death). If they later sell the property for $250,000, then, poof! That $100,000 worth of capital gain just disappears. Unfortunately, lifetime gifts don’t get a “stepped up” basis. Instead, those lifetime gifts pass your basis in the property to the recipient (called a “carryover basis”). So, using the same example, if you’ve added a child to your Deed as a joint owner, then he or she will receive your $150,000 basis in the property, and when the property is later sold for $250,000, there will be taxable gain of $100,000 on the sale.
You’ve Potentially Caused an Estate Tax Problem for the Joint Owner. When a joint owner (other than a spouse) dies, the tax law treats him or her as owning 100% of the value of the jointly held property, and includes the entire amount in his or her estate to determine whether estate taxes will be due. This can be rebutted by showing what (if anything) the deceased owner actually contributed to the property, but proving that with documentation can be difficult, if not impossible, especially if years have passed.
You’ve Possibly Disinherited Your Other Children. Making your daughter a joint owner with rights of survivorship on your account ensures that, when you die, the account will pass directly to her. However, she will be under no legal obligation to share that money with your other children. What if your daughter wants to share those assets? Those transfers will be gifts from her to the recipients, triggering her own potential gift tax issues.
What’s the Solution? Fortunately, there are planning options that can provide you with the same convenience as joint ownership, without the tax issues and other risks. Stay tuned for next month’s column.
Cheryl A. Jones is an estate planning attorney at Pessin Katz Law, P.A and can assist you with wills, trusts, estates, second parent adoptions, and other legal issues. Cheryl can be reached at 410-769-6141 or firstname.lastname@example.org.