Estate Planning Hits Home When Residences Are Involved

Clients who jump into joint ownership of their homes to circumvent probate may land in unintended situations that other strategies could avoid.

With low interest rates causing many retirees to dip into their investment principal, and housing prices having risen since the economic downtown in 2008, practitioners may find that residential real estate comprises a large portion of some of their clients' estates. The illiquid nature of real estate however, can increase the difficulty of formulating estate plans that achieve client goals and objectives when the client's wealth is heavily weighted with real estate.

When planning with residential real estate, practitioners should first look to the title of the property. The method in which title is held may affect the type of planning that can be done with the property.

Tenancy choices

Generally, if a deed does not specify how title to real property is held, the owners are deemed to hold the property as tenants in common with equal interests. The default treatment when the type of tenancy is not specified may vary from state to state, especially for clients who are located in community property states. When title is held as tenants in common, upon the death of a co-owner, the interest passes under the deceased owner's estate plan or to his or her heirs-at-law. The interest does not pass automatically to the surviving owner or to the surviving owners.

If the deed states that the owners are to be treated as joint tenants, then each owner is treated as owning an undivided interest in the entire property. Joint tenants may have made unequal contributions to the property but each joint tenant is still treated as owning the entire property.

Joint tenancy can be severed by either joint tenant conveying his or her interest to another person. When an interest is held in joint tenancy, upon the death of a cotenant, the property automatically passes by law to the surviving co-owner regardless of the terms of the estate plan created by the deceased joint tenant. This is the primary difference between joint tenancy and ownership by tenants in common. Each joint tenant's interest terminates upon death.

Joint tenancy

An advisor may come across new clients who have titled or desire to title assets in joint tenancy as a means of avoiding probate. Elderly clients may have done internet research or spoken with friends who placed their residence in joint tenancy to avoid probate. These individuals may not realize the limitations of holding title in joint tenancy.

Although joint tenancy property will avoid probate, the client may find that other consequences of joint tenancy make this form of real estate ownership inappropriate for the client's individual situation. The following examples illustrate common situations where this occurs:

Example. An advisor meets with a client and discovers that the client's daughter is a joint tenant on the client's home. The client intends that the daughter divide the proceeds from the sale of the home after the client's death with her siblings. If the daughter follows these instructions, however, she will likely have made a taxable gift which could require her to pay gift tax if she already used her applicable estate and gift tax exclusion.

Example. Ann is an unmarried individual in her 70s with an estate of $1 million, of which $750,000 is the value of her home. She has two daughters, one of whom lives nearby and is caring for her; the other is situated a considerable distance away. Ann desires to place her home into joint tenancy with her daughter who resides locally. If Ann's will provides for assets to be divided equally among her children, and Ann intended this equality to apply to her entire estate, one of the daughters will receive a disproportionate share of the assets due to the residence passing to the surviving joint tenant.

In addition to the potential loss in value to other family members, there are several disadvantages to using joint tenancy to hold title to real estate. The primary disadvantages are as follows:

Loss of control. The consent of each co-owner is required in order to dispose of the property. Further, both parties' signatures are required to transfer or mortgage the property. If one joint owner refuses to participate in any of these transactions, the other owner would have to file a court action to sever the joint tenancy or force a sale of the property.

In the example above, if Ann wanted to sell her home, her daughter may disagree and refuse to sign the sale documents. Even if at the time of the creation of the joint tenancy, the daughter gave assurances that she would do whatever her mother asked with regard to the house, as time passes and circumstances change disagreements can arise unexpectedly even in the closest families.

Loss of creditor protection. Jointly held assets are fully available to the creditors of either joint tenant regardless of contribution. In order to satisfy a creditor's claim, a foreclosure could be initiated.

If Ann's daughter was sued by a creditor to recover a debt, Ann could lose her home if the home was the only asset available to satisfy her daughter's debt. If Ann's daughter had contributed some or all of the purchase price of the home to assist her mother financially, that investment could be at risk if Ann ran out of assets and needed to apply for public aid. If Ann is on the title to the residence as a joint tenant, then the entire value of the property would be a countable asset for purposes of determining Ann's eligibility for aid.

Tax consequences. As stated above, the creation as well as the termination of a joint tenancy interest can have gift tax consequences.1 When the sole owner of a personal residence places a nonspouse, such as a child, on the title to the individual's residence as a joint tenant, he or she has made an immediate gift of one-half the value of the property. For example, when Ann retitled her $750,000 home into joint tenancy with one of her daughters, Ann gave that daughter a $375,000 gift. The gift tax annual exclusion may shelter all or part of the gift. But if the gift is not fully sheltered, Ann would have to...