Joint Tenancy and Estate Planning
Q: Several weeks ago, you discussed the pros and cons of a parent adding an adult child to his or her home deed as a joint tenant as a way to avoid probate. However, the wisdom of this move apparently hinged on the income tax consequences upon the parent’s death and the child’s subsequent sale of the home. I am confused by your advice and wonder if you would take another try at clarifying the matter. --M.R.
A: Unfortunately, that column confused--and misinformed--you and countless other readers. So, with apologies to all, we’ll take another crack at getting it right.
The goal of most estate planning efforts is to minimize both estate taxes and income taxes due upon the heirs’ sale of the estate. Avoiding probate is often another major objective. For many, the perfect estate planning arrangement would accomplish all three. When an estate has a value of less than $600,000, joint-tenancy vesting of a home between a parent and his or her adult children or other heirs can achieve this.
One of the principal virtues of putting assets in joint tenancy is that it allows heirs to bypass the probating of the will. Property simply passes to the other joint tenant(s) without the hassle and expense of the probate process. Further, when an estate is worth less than $600,000 and no estate tax is due, joint tenancy allows heirs potentially to escape income taxes on all the profits they realize from selling the property. In essence, you can have your cake and eat it, too.
Why? Alex Fried, an Encino attorney specializing in estate planning, explains that the federal tax code requires the entire joint tenancy property to be included in a deceased’s estate if the other party to the vesting acquired the interest for no consideration. This means that when Mom or Dad put the kids on the deed as joint tenants, because the kids paid nothing toward the purchase or maintenance of the home, the home is included in the parent’s estate for the purposes of computing estate taxes.
Now what happens? In estates of less than $600,000 in value, there is no estate tax. Still, any property included in an estate tax computation--whether or not taxes are eventually paid--is treated to a full step-up in its basis to its value on the deceased’s date of death. This is especially welcome news for the heirs. When they sell the property, its tax basis is the home’s value as of the parent’s death, so their potential income tax responsibility is minimized.
Why did we get the answer wrong the first time? We were under the mistaken impression that when estate taxes were not levied, the property involved would not be treated to the full step-up in value because the IRS would want either payment of estate taxes or income taxes on the surviving tenant’s gain. However, Fried says, IRS Revenue Ruling 56-215 specifically states that entitlement to the full step-up does not require actual payment of estate taxes. He also notes that, except when proven otherwise, property of the deceased is presumed to belong in his or her estate for the purpose of assessing any estate taxes. So, when an estate is worth less than $600,000, joint tenancy can keep the government from getting a piece of the action. However, to be absolutely safe, Santa Monica tax attorney Tom Nitti says he advises clients in this situation to have the property appraised immediately after the parent’s death, to prove to the IRS that the estate does not exceed the $600,000 limit.
What’s the conclusion? On the surface, it would appear that joint tenancy between parent and child is a terrific estate planning tool, especially for parents with estates worth less than $600,000.
Fried cautions against rushing to that conclusion, however. One significant problem with joint tenancies between parent and child is that they are irrevocable. If the parties have a falling out, the kids are still on the deed. Further, joint tenancy exposes all parties to the debts and obligations of the others. If the child you made the joint tenant on your home is successfully sued, you could be forced to sell your home.
These are the major reasons that attorneys and accountants often advise clients to consider living trusts as a means of both bypassing probate and ensuring a full step-up in the property’s value. There is a difference in cost, however. Filing a joint tenancy record with the county essentially costs nothing; having an attorney draft a living trust will cost at least $1,000.
One more note: Married couples are advised to avoid joint tenancy in favor of community property vesting. Surviving joint tenant spouses are not treated the same as other joint tenants and do not receive the full step-up in basis upon the death of first spouse. But this is another subject, and one that we have dealt with extensively on other occasions.
The Pros and Cons of a 3rd Mortgagee
Q: My wife and I want to refinance our home. Because I recently retired, the bank says we do not have sufficient monthly income to qualify for the new loan. Our son is willing to pay 25% of the monthly mortgage costs. May he deduct that share of the mortgage interest? Does his name have to be on the trust deed and title? Are there other matters we should consider? --W.A.L.
A: If your son actually will have to contribute to the monthly mortgage payment, then he should be included on the deed and title. He will be entitled to deduct his share of the mortgage interest by claiming your home as his second residence. If, however, he already has a second home, he will not be entitled to another interest deduction from his income.
Here is another approach: Why not have your son co-sign your new loan? This would be an especially good idea if, despite the bank’s assessment, you are able to pay the monthly mortgage by yourself.
This way you would avoid the issues of whether your son is co-owner of the home, whether he is entitled to a mortgage interest deduction and whether you are giving an interest in your home to your son. It also preserves your full entitlement to the $125,000 profit exclusion from income tax liability allowed home sellers 55 or older.
