Property title questions during financial planning interviews often draw blank stares. Yet, understanding the differences among tenants-in-common, joint tenancy and community property is important for creditor protection issues, estate planning, and marital dissolution.
Tenancy-in-common is the most common way property is titled when two or more non-spousal people own a single piece of property. Parents may own property with children as tenants-in-common. Business partners and unmarried domestic partners are likely to have this type of property title.
Since one co-tenant cannot act on behalf of another, and each is not liable for the acts or omissions of the other co-tenants, creditors can assert a claim against only a portion of the property evidenced by a co-tenant’s interest. And, the value of the property is decreased since only a portion is available for creditor claims.
In estate planning, a co-tenant has all the rights of a sole owner for his/her portion of the property. This includes the power of appointment to give an interest away while alive or leave, by will, an interest at death. For gift or estate tax purposes, the value of a co-tenant’s interest may be discounted if the new co-tenant does not enjoy the total ownership of the property.
Joint-tenancy differs from tenants-in-common in that the property is exposed to the claims of each tenant’s creditors. Parents often make the mistake of titling their residence with children as joint-tenants with rights of survivorship. This allows the property to pass to the surviving joint tenant upon the death of the first to die, without going through probate. However, parents unknowingly expose themselves to the creditor risks of their children when they title property in joint-tenancy. A parent giving a joint-tenancy interest in property to a child also creates a taxable gift for the value of the transferred interest. If the gifted value is greater than $13,000, the parent must file a gift tax return and possibly pay a gift or transfer tax.
Since a joint-tenancy arrangement passes the property to the surviving joint tenant, the decedent tenant has no power of appointment over that property at death. Parents holding property in joint-tenancy have effectively disinherited their children since the first parent to die cannot appoint his/her interest in the property to an heir by means of a will.
Finally, when a joint tenant dies, the surviving tenant is deemed to have received a gift from the deceased of one half of the value of the property. This inherited half receives a stepped-up cost basis equal to the value of the property at the date of death. Unlike community property, the half interest retained by the surviving joint tenant retains the original cost basis.
Community property states, such as California, treat property held and titled by married couples as community property similar to joint tenancy with two very important exceptions. At the death of the first spouse, the decedent has full power of appointment or the ability to give his/her interest to whomever he/she pleases. Most commonly, the property will be left to the surviving spouse to use for the rest of his/her life, then passing to the children. At death, the property receives a full stepped-up cost basis, enabling the surviving spouse to sell the property without a capital gains tax.
In the event of marital dissolution, joint-tenancy and community property is treated as being owned in equal shares by each spouse.
- Tenancy-in-common is the most common way property to title property but is not always the best way. Consider your options carefully.
- Paying inheritance tax can be better than paying capital gains tax for your heirs. Title property to take advantage of the best outcome.
- Community property is similar to joint tenancy with two very important exceptions. Know the exceptions when you live in a community property state.