Unsnarling a Joint Tenancy Dilemma

Question: About 15 years ago, when my father died, my mother put me on as a joint tenant on her house. I am now concerned if we should keep it in joint tenancy. When my mother dies, she wants the proceeds divided between me and and my two brothers. When my mother passes away, I plan to sell the house and give each of my brothers a third of what I receive. From what I gather, it seems it is not that simple. When my parents bought the house in 1972, the house cost $29,000 and it is now worth $350,000. As it now stands, if I divide the money would I personally be liable for capital gains on the appreciation? Would it be better to put the house back solely in my mother’s name so when my mother passes away it becomes part of her estate, thus not subject to estate taxes (the house is her only major asset)?

--H.O. Thousand Oaks.

Answer: You’re right, it’s not that simple. Your dilemma illustrates the danger of using joint tenancy as an estate planning device, especially as in this case when the joint tenant is not the only person who is supposed to receive the property. (Your mother also wants your brothers to share the proceeds.)

There are at least two potential problems, both tax related: gift tax and capital gains tax when the house is sold.

You should consult an experienced estate and tax lawyer who can be fully briefed on all of the facts and give you the best advice for your situation. With a house worth $350,000, the potential tax complications could be very serious and it will be worth the investment in a lawyer’s time. But let me explain some of the general concepts.

The advantage of holding property in joint tenancy is that it is “automatically” transferred upon death without having to go through probate. (There is still some paperwork involved; you must file an affidavit of surviving joint tenant and other papers with the county recorder.)

But there are risks associated with joint tenancy as well. The first problem strikes when you change the deed from sole ownership to joint tenancy. There may be a reassessment of the property under Proposition 13. And it is possible that the transfer of ownership will be considered a taxable gift.

Let’s assume you somehow avoid problems at that end. Then there may be problems after the death of one of the joint tenants.

In this case, for example, what happens after the son who is a joint tenant inherits the house and shares the wealth with his brothers. A gift tax problem will probably arise when he tries to divide the proceeds from the sale of the house. He will probably be seen in the eyes of the law as the sole owner, and whatever is given to his brothers will likely be viewed by the IRS as a gift and tax will be due.

Obviously, if you were the only son, you wouldn’t face the problem of sharing the proceeds, but there is another potential issue, and that has to do with the “stepped up basis”

For that, you need some background. Under IRS rules, when you buy property, the original value of the property, usually the purchase price, is your “basis” in the property. When you sell the property, you are taxed on the difference between the selling price and your basis. Upon death, to the benefit of your heirs, the basis in your property is increased to its fair market value at the time of your death. This is the so-called “stepped up basis.”

When a house is owned in joint tenancy, it becomes more complicated. If it is a true joint tenancy, that is, each tenant has contributed to the purchase of the property, and one of them dies, then the stepped up basis only applies to the half of the property owned by the person who died. It’s not as clear what happens to the stepped up basis if each joint tenant did not actually contribute to the purchase of the property, for instance, if a name was just added to the deed.

Now, you can see why you need to consult a lawyer. And there are other complications I haven’t mentioned. The lawyer may advise you to return the house to your mother’s sole ownership and have a will or trust prepared for her that divides it between you and your brothers. But even that strategy has pitfalls since your gift back to your mother of your share of the house could be viewed as a taxable event. And the stepped up basis may not apply to a gift of property to someone who dies within a year.

Had enough? Go see a lawyer.