Joint tenancy agreements are a popular method of avoiding probate. It works well and doesn't cost anything.
The most common probate-avoidance tool is joint tenancy. Why not? Joint tenancy property automatically transfers to the surviving owners without probate when one owner dies. It is simple to set up a joint tenant, and it does not cost anything.
When married couples acquire valuable property, such as real estate, vehicles and bank accounts, or securities together, joint tenancy is often a good option. However, there are some drawbacks to joint tenancy (described below), particularly if you own property and want to make someone else a tenant to not go through probate.
Many states allow married couples, or registered domestic partners, to take the title in "tenancy by all" rather than in joint tenancy. As a result, both can avoid probate in the same way. This section explains the rules for joint tenancy.
A glance at Joint Tenancy
- It is easy to make.
- After the death of one owner, it is easy for the survivor or beneficiary to transfer title.
- It can be used for cars, real estate, bank accounts, stocks, and many other items.
- In certain states, creditors may not be a concern for the survivor. Joint tenancy property in these states is not subject to creditors' claims after the death of one owner. Instead, it is only subject to claims for debts that both tenants jointly own.
- Two or more tenants can be joint tenants.
- The last remaining joint tenant must use another method to avoid probate upon their death.
- Probate cannot be avoided if both owners are dead simultaneously (a rare event).
- Each owner's share must be equal (except for Colorado, Connecticut, Ohio, Vermont).
- If you own property, adding a tenant is possible by giving half your interest in the property.
How joint tenancy avoids probate
The surviving owners receive the deceased owner's share in the joint tenancy property when one joint owner (also known as a joint tenant) dies. The "right of survivorship" automatically transfers the deceased owner's share to the survivors. The property does not go through probate court. Instead, the survivor(s), who need to shuffle some paperwork, can get it into their name.
The steps will vary depending on the property. However, the general procedure is to fill out a simple form and submit it to the keeper or ownership records with a death certificate. This could be a bank, the state motor vehicle department, or the county real estate records officer.
Example: Evelyn, her daughter Miya, and their car are joint tenants. They have the right to survivorship. Evelyn's half-interest in her car will pass to her daughter, without probate, when she dies. Miya will only need to complete a form and file it at the state motor vehicle agency to get the car registered in her sole name.
You cannot give your share to any other joint tenants if you are a joint tenant. Even if you leave your half-interest in the joint tenancy house in your will, it does not have any effect. After your death, the surviving joint tenant will automatically own the property.
This rule may seem more ambiguous than it is. In most cases, a joint tenant can unilaterally and quickly end the joint tenancy.
Example: Eleanor, Sadie, and their house are joint tenants. Eleanor signs a document (and records it at the county land records officer) to transfer her half-interest from herself, as a joint tenant, to herself as "tenant in common." Tenancy in common refers to a form of co-ownership without the right to survivorship. Eleanor can then leave half of her interest in the property to another person in her will, ending the joint tenancy.
You can also sell your interest to another person. The new owners of the interest will not be joint tenants but will instead be "tenants-in-common." Tenancy in common property does not confer any right to survivorship.
Example: Sean & Alice jointly occupy a beach house they inherited from their parents. Sean transfers his half-interest to his children, making them tenants in common. Sean will inherit Alice's interest, but not her half-interest. Instead, she will give it to her children.
Limitations on Joint Tenancy
The effectiveness of joint ownership as an anti-probate strategy has its limits.
When the last owner passes away, probate cannot be avoided. Joint tenancy does not include the probate-avoidance section. It only applies to the death of the first owner. If there are three joint tenants, the probate-avoidance part of joint tenancy works only at the end of the incapacity of the first co-owner. The property must be probated after the death of the last co-owner unless the previous owner used another probate-avoidance technique, such as transferring it to a living trust. You can, however, use other probate-avoidance tools such as living trusts and payable-on-death accounts to name a beneficiary who will be freed from probate if the second owner dies.
If both owners are deceased simultaneously, probate cannot be avoided. If this happens, the will of each owner would determine which owners share the property. According to state law, if a joint tenant dies without a valid will, the property would be transferred to each owner's nearest relatives. Probate would likely be required in either case.
The incapacity of one owner may make it difficult for others. The freedom of the other owners to make decisions will be limited if one owner becomes incapacitated. If each joint owner signs a document known as a "Durable power of attorney," it will allow someone to manage their affairs if they cannot do so or if the property is given to a living trust.
The drawbacks of adding a new joint tenant to avoid probate
When an older person wants to avoid probate but still needs to plan for their estate, joint tenancy is a wrong choice. This creates many potential headaches by adding another owner.
You are giving away property. You give up half of your property if you make another person a joint tenant on a property you own. The new owner can sell, mortgage, or lose their share to creditors or separation.
Example: A mother in Arizona added her son as a joint tenant to her condo as an owner. The mother paid all costs and income from renting the property to tenants. However, the IRS sued the son later for unpaid income taxes. The condo was eventually sold to pay the taxes. Half of the proceeds went to the mother. She sought the remaining half and argued that she was the true owner, as the joint tenancy was only created for estate planning purposes. She was unsuccessful. (Nikirk v. U. S., 2003 WL 22474742 (D. Ariz. 2003).)
Transfers may attract gift tax. Gifts to one person (other than your spouse) exceeding the annual federal gift tax exclusion ($16,000 for 2022) must be filed with the IRS. However, no tax is due unless you give or leave many taxable gifts ($12.06 million 2022).
One exception is that if two or more people have a joint bank account, and one person deposits all or most of it, there is no gift tax. Because the contributor can withdraw the money, it is assumed that no gift has been made. However, a taxable gift can be made if the other joint tenant takes money from it. (IRS Priv. Ltr. Rul. 94-27003, 1994)
This could lead to disputes following your death. Many older people make the error of adding a joint tenant to their bank account for "convenience." They need someone to deposit checks and pay bills. The co-owner can claim, as surviving joint tenants, that the funds in the account are his or hers after the original owner's death. Sometimes, this may be what the deceased intended. Unfortunately, it's too late for you to find out. This confusion can lead to permanent and bitter family rifts that are sometimes fought in court.
You can open a "convenience account" or give a trusted individual power of attorney if you only need someone to write your checks. You can give anyone you choose the authority to access your money, but only for your benefit.
An income tax break may not be available to a surviving spouse. For example, you can make your spouse a joint tenant on separate property. The surviving spouse may not be eligible for a significant income tax break when the property is sold.
This problem should only be addressed if:
- You own separate property and would like to make your spouse a joint tenant now, rather than leaving it to your spouse at your death.
- The property's worth has increased (or you anticipate it will).
- You don't reside in a state that is a part of a community. These are Arizona, California, and Idaho.
Understanding the IRS' tax basis rules will help you understand the problem. Tax basis is the taxable profit calculated when a property is sold. The basis is usually the price you paid for the property with some adjustments. For example, if you buy an antique at $100, this is your basis. You can subtract $100 from the price of your antique to get $400 if you decide to sell it 20 years later. This will leave you with $300 in taxable profits.
If you own property and leave it to your spouse, your tax basis is the current market value when the property was inherited. The basis will increase if the property's value has increased (or "stepped up" in tax jargon). This is good because the property will be sold with a lower taxable profit.
However, if the solely-owned property is transferred to joint tenancy, the tax basis for the half you give remains the same. It has not increased. 26 U.S.C. § 2040.
As mentioned above, couples who live in community property states have a special rule: When one spouse dies, both halves of the community property are given a higher basis. Even if the community property is in joint tenancy, this applies. In such cases, the surviving spouse must prove to the IRS that the joint-tenancy property was actually community property. That is, it was purchased with community property funds. The IRS will follow the title documents that state joint tenancy. It may be more beneficial to hold the title as community property from the beginning.