Avoiding probate is “the thing to do,” but joint ownership of assets is not the way to do so. Joint ownership in the form of a joint tenancy deed to real estate or jointly owned bank and investment accounts can lead to undesirable tax consequences. There are also several other “pitfalls” to any form of joint ownership.
Parents often decide to “put the children on the deed.” This may create unexpected gift tax liability. If parents put their daughter's name on the deed to a $600,000 home, they have just made a $200,000 gift. Depending upon other previous gifts, they may have unknowingly incurred $74,000 or more of gift tax liability (gift tax rates currently start at 37% and climb quickly to 50%, much higher than the income and capital gains tax rates). Upon the death of the first joint tenant, only that tenant's share of the property gets a “stepped-up” tax basis. If the surviving widow and daughter decide to sell the house, they may owe substantial capital gains tax on the portion of the property which still carries the original tax basis.
There is a simple solution. Instead of putting their daughter on the deed, if the parents signed a community property agreement, declaring that all joint tenancy property is actually community property, then the entire home receives a stepped-up basis on the death of the first spouse. The $600,000 house can be sold immediately without any capital gains liability, even though the couple may have paid only $27,500 when they purchased their home 40 years ago. In addition, if the house is deeded to the couple's living trust while they are both still alive, there will be no probate and their daughter will eventually take over as successor trustee and beneficiary without any court proceeding.
Besides the tax consequences, there are several other potential pitfalls to joint ownership: (1) Any joint tenant can “sever” the joint tenancy without notice; (2) Joint tenants may not die in the order expected; (3) The sole surviving joint tenant still needs to do something else to avoid probate (such as create a living trust); and (4) In the event of a “common disaster,” the property will still go through probate.
In the case where the other joint tenants are children, property could be lost because of a judgment against the child, or even a dissolution of the child's marriage. Often family disagreements arise after the death of a parent who placed substantial assets in joint tenancy with one child only; other children claim this was a “convenience” to avoid probate, and the child with the surviving joint tenancy is supposed to share equally with the remaining siblings. This can lead to substantial difficulties in the family and possible lengthy litigation which was not the intent of the parent.
There are many reasons to avoid joint tenancy and to look to other means, such as the living trust, to avoid probate and unwanted tax consequences.