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In its various forms, co-ownership of property by two or more persons is one of the predominant ways in which property is held in the United States. Co-ownership interests can be characterized as:
Each form of ownership gives parties different ownership rights in the underlying property. Although the characterization and legal effect of a particular property interest is determined under applicable state law, federal taxation of such interests is determined under the Code.
Note: Unless otherwise noted, the term "joint tenancy" refers to joint
tenancies with right of survivorship.
For purposes of federal estate taxation, joint tenancies between spouses and tenancies by
the entirety (a form of spousal co-ownership applicable in some states) are treated the
same. Although individual state law varies, typically the most salient difference between
the two ownership forms is that with respect to tenancies by the entirety greater
restrictions are placed upon a tenants right to unilaterally sever the tenancy.
Joint Tenancies Between Spouses
It is a popular conception (one generally not shared by estate planners) that joint tenancy with survivorship rights is always the best form of asset ownership between spouses. Although joint tenancies between spouses have advantages, they also may result in additional; estate tax liability.
In the case of property jointly owned by spouses, the estate of the first spouse to die includes one-half of the value of the property regardless of which spouse furnished the consideration for the property. Although this rule may facilitate qualification for special tax law provisions, the unlimited.marital deduction may make it inadvisable for estate owners to place individually owned property into joint tenancy.
The provision for the unlimited marital deduction makes it possible for an estate owner to hold assets individually until death, and then transfer the property by will to his spouse without estate tax liability. By doing so, the surviving spouse can receive a stepped-up income tax basis for the entire value of the property.: If the estate owner transferred the property into joint tenancy, his spouse would receive a stepped-up basis only for the one-half interest acquired from the decedent at his death (she would have a basis carried over from the estate owner in the one-half interest transferred to her during his lifetime).
The ease and speed of transfer of joint tenancy property to the surviving spouse is one of two major advantages to spouses holding property in joint tenancies. Because title to jointly held property automatically passes by operation of law to the surviving joint tenant on the death of the first tenant, court action is not required. Thus, the survivor will not have to relinquish control of the property to the decedents estate, but can maintain continued use of the property.
The fact that, upon the death of a joint tenant, the property automatically passes to the surviving joint tenant also leads to savings in estate settlement casts. Because joint tenancy property passes outside of probate,
Although ownership of property by spouses in joint tenancy has its disadvantages, the disadvantages are often outweighed by its advantages, particularly where a married couple does not have sufficient assets to incur estate tax liability. For such individuals, the ease of transfer and avoidance of probate expenses are paramount considerations impelling their use of joint tenancies.
Even if holding assets in joint tenancy produces adverse estate tax consequences, it may nevertheless be advisable:with respect to two categories of property:
Qualification for special election percentage requirements
The law that makes the fact of contribution of consideration irrelevant for joint tenancies held by married persons, coupled with the unlimited estate and gift tax deductions, allows an estate owner to make tax-free transfers into joint tenancies for the purposes of meeting the percentage requirements for electing
If qualification for any of these special provisions is desired, an estate owner's transfer of individually owned non-business property into joint tenancy with his Spouse would have the effect of increasing the percentage of closely held business assets in his gross estate at death. Conversely, placing the business interest itself in joint tenancy between spouses generally would not be advisable within this context, because doing so would reduce the percentage of the business interest in the decedent's estate. Although .interspousal transfers of property into joint tenancy can be accomplished:without incurring gift tax liability, the potential advantages of qualification under the above special provisions should:be weighed against the general advantages and disadvantages of the joint tenancy form of ownership.
Disadvantages and Alternatives
Property held-jointly by married couples has several disadvantages. First, inclusion of one-half of the value of the property in the gross estate of the first spouse to die will mean that the surviving spouse will receive a stepped-up income tax basis only on one-half of the value of the property. Second, the estate owner cannot control in any way the disposition of the property after his death (since the survivor automatically takes title individually at his death).
As noted, above, the estate owner's creation of a joint tenancy with his spouse will mean that the surviving spouse will receive a stepped-up basis for only one-half of the property at his death. If, instead of creating the joint tenancy, the estate owner retained the property individually until death, the surviving spouse could receive the property free of estate taxation and acquire stepped-up basis (to fair market value on the date of the spouse's death) for the entire property. Upon a later sale of the property, the income taxes saved by the surviving spouse might more than offset the probate cost savings that would have been realiized if the property had been held in joint tenancy.
A second advantage of the estate owner's retention of the property individually is that
he retains complete control of it until death and may control to some degree its use ad
disposition afterward as well.
Another method that allows the estate owner to retain control over the property while possibly freeing him from daily management of the property is the establishment of a revocable trust for the benefit of his spouse. Although such a revocable trust does not create tax savings (for either income tax or estate tax), it can be arranged so as not to generate any estate or gift tax liability because of the unlimited marital deduction
Individuals who are, or have been, domiciliaries of Arizona, California, Idaho,
Louisiana Nevada, New Mexico, Texas, Washington,.or Wisconsin must consider the effect of
the community property law on the estate tax plans. The basic rule is that property
acquired during marriage by persons domiciled in a community property state is owned
one-half by each spouse, regardless of which spouse supplied the consideration for its
purchase (if it is an asset) or earned it (if it is income).
Consistent with state law characterization of community property interests, only one-half
of the value of such interests are includible in the spouses' federal gross estates. In
light of the unlimited marital deduction and the fact that community property fully
qualifies for this deduction, estate tax liability need not be incurred on the death of
the first spouse to die, whether property passing to the surviving spouse is community
property;or is separate property.
Thus, the question of whether property is separate or community property is only relevant with respect to planning to qualify the estate for the percentage tests for the special use valuation; the election to pay estate taxes in installments; and the redemption of close corporation stock to pay death taxes. If the estate tax plan of the estate owner indicates the advisability of qualifying for any of these provisions, holding non-business property as community property would facilitate the election; holding business property as community property would make the election requirements more difficult to achieve (by reducing the percentage of the business interests in the decedent's estate).
Unlike the case of joint tenancy, a surviving spouse in a community property state who ends up with the entire property by acquiring the deceased spouse's one-half interest in property will receive a stepped-up income tax basis in the entire property,
Joint Tenancies Between Non-Spouses
In contrast to the estate tax treatment of jointly held property with right of survivorship between spouses, where non-spouses hold property in joint-tenancy, the entire value of the property will be includible in the estate of the first joint tenant to die, except to the extent that the decedent's estate can prove that the surviving tenant contributed consideration for the acquisition of the property. Thus, the full value of the property may be included in the decedent's gross estate, even though during lifetime he may have had (depending on the operation of applicable state law) only one-half of the income from the property.
An additional problem regarding joint tenancies between non-spouses is that gift tax liability may arise on the creation and/or termination of the joint tenancy.
The above disadvantages usually seem to outweigh the advantage of avoidance of probate expenses, at least for states with substantial estate tax liability.
If property is held in tenancy in common, each tenant in common possesses an undivided interest in the property. These interests are distinguishable from joint tenancies by the absence of survivorship rights. Each tenant, in common has the right to transfer his undivided interest during his lifetime, or at death.
At death, an estate owner's tenancy-in-common interests are included in his gross estate. However for purposes of valuation of such an interest, a strong argument can be made that the valuation of such an interest should be less than a proportional fractional share of the underlying property's fair market value, since a fractional interest in a property is less desirable and less marketable than an entire interest.
Although a tenancy in common might also be seen as a way of accomplishing income splitting among family members, problems of non-marketability of interests (important only if one of the tenants needs to raise money) and possible disputes among joint- tenants seem to mitigate against it as an ownership form for estate planning purposes.
