Joint Ownership as an Alternative to Estate Planning (Part 1)

Joint ownership is commonly thought to be an easy alternative to estate planning. Perhaps you (or your parents) have kicked around the idea of adding the name of a trusted adult child on a checking account or the title to your home. The thought is that as Mom (or Dad) gets older, the

child, as a joint owner, will be able to access the accounts to pay bills if the parent is incapacitated. Then, after the parent’s death, the child can be counted on to distribute the cash and property to the other siblings fairly. All without the need for a power of attorney or a will or trust and without stepping foot into the probate court or an attorney’s office. Sounds like a pretty simple and cheap alternative to estate planning—after all, those lawyers are always complicating things just so they can charge higher fees, right? But joint ownership can come with some unintended (and serious) consequences for both parent and adult child, and here’s how:

Under Utah law, joint ownership occurs in two ways: as joint tenants with rights of survivorship (JTWROS) or as tenants in common. If you want to use joint ownership to pass property upon your death, you must create a JTWROS. Upon one joint owner’s death, the property automatically becomes the property of the surviving joint owner. In contrast, when two (or more) people own property as “tenants in common,” the property does not automatically become the property of the surviving joint tenant, but the deceased’s interest in the property passes to his or her estate instead.

Example: Tom and Sue own a bank account as JTWROS. When Tom dies, Sue automatically becomes the owner of the entire account. In contrast, if Tom and Sue own the account as tenants in common, when Tom dies, his interest in the account does not pass to Sue but becomes part of his estate to be distributed according to the terms of his will or trust or as determined by the probate court.

Problem #1: Capital Gains Taxes
Let’s take a look at unintended consequence number one: capital gains taxes. Using joint ownership as a substitute for estate planning may save you some moola in attorney’s fees but could likely result in a windfall for Uncle Sam.

I’ll try to keep the boring legalese to a minimum here, but as a simplified general explanation, capital gains taxes are imposed on the appreciation of certain property (so-called “capital assets”) held for more than one year. When a person buys a capital asset, the purchase price of that asset is the “basis.” If the asset is held for a year or more and then sold at a price higher than the basis, the difference between the two is the “gain.” Currently, the tax rate for capital gains is 15% (although as the law now stands, the capital gains tax will increase to 20% after 2010).

Example: Tom buys 100 shares of stock in ABC Corporation at $10 a share. His basis is $1,000. When Tom sells the stock five years later, the price of the stock has increased to $50 a share for a gain of $4,000. At a 15% tax rate on that gain, Tom owes $600 in taxes.

If, however, the appreciated capital asset is part of an estate, the estate tax laws give the heirs a nice break by giving them a “step up” in basis. What this means is the basis for calculating any capital gains is the value of the asset at the time of the deceased’s death instead of the value of the asset at the time the asset was acquired.

Example: Tom buys 100 shares of stock in ABC Corporation at $10 a share. When Tom dies five years later, the stock, now valued at $50 a share, is distributed to his children through his living trust. The children’s basis in the stock is $5,000, the value of the stock on the date of Tom’s death. If the children now sell the stock for $5,000, they will owe nothing in capital gains taxes.

So, here’s where the real kicker is: when someone adds another person’s name to the title of their property (creating a joint ownership situation), that person also receives the same tax basis for that property. When the surviving joint owner sells the property, the tax treatment will be the same for the surviving owner as it would have been had the property been sold by the original owner. This can really hurt the ol’ pocketbook.

Example: Mom purchases a home and surrounding land for $100,000. Thirty years later, the value of the home and land has appreciated to $300,000. Shortly before her death, Mom adds Daughter to the title of the property. Daughter receives Mom’s basis of $100,000. When Daughter sells the property, realizing a gain of $200,000, she will owe $30,000(!) in taxes.

Had Mom distributed her property to Daughter through a will or living trust, Daughter would have owed zip, zero, zilch in capital gains taxes. Remember, the estate tax laws currently give the heirs of an estate a step up in basis, so Daughter’s tax basis for the property would have been $300,000—the value of the property on the date of Mom’s death. When Daughter sold the property for $300,000, her tax liability would have been $0.

I know I’m leaving you on the edge of your seat here, but in the next post, we’ll look at how joint ownership can also cause gift tax problems.