An unmarried, sole owner of real property in California often avoids probate by adding a co-owner in joint tenancy. This post identifies the surprise and peril for non-spouse, joint tenant owners, and viable alternatives.
Adding a joint tenant co-owner who is not a spouse to the real property opens up the possibility of many unintended consequences. This post identifies the perils of and alternatives to co-ownership. The unintended consequences are; unfavorable tax treatment, exposure to the new owner’s creditors, relinquished control to sell and mortgage the real property, and failure to transfer due to a random order of death.
Joint tenancy is a form of co-ownership of real property where more than one person owns the real property, and each owner has equal ownership. In addition, every joint tenancy includes a “right of survivorship” such that, upon the death of one joint tenant, the deceased joint tenant’s share of the asset transfers to the surviving joint tenant or tenants at the moment of death without the need for probate administration.
The title is cleared by recording an affidavit of death of the joint tenant with a death certificate attached. Joint tenancy overrules wills and trusts. This change of ownership is easy to understand and is low in cost.
Surprises and perils
The first surprise with joint tenancy is unfavorable tax treatment. The new joint tenant’s ownership interest is increased to fair market value for the property tax base.
The next surprise is an increase in capital gains tax. Lifetime gifts of real property transfer the original owner’s purchase price or “basis” to the new co-owner. Death transfers of real property receive an adjusted basis to fair market value as of date of death. So, for lifetime transfers of real property with a low purchase price compared to a higher current market value the result is an additional capital gains tax on the subsequent sale of the real property.
The second surprise and peril is the new co-owner. The new co-owner’s creditors can use the real property as a source of repayment. Additionally, the new co-owner must sign off on any sale or financing that uses the real property as collateral. A new co-owner takes away control from the original owner.
Alternatives to Joint Tenancy
Revocable Transfer on Death Deeds (TODD) and revocable living trusts are good alternatives to joint ivtenancy. A TODD does not change ownership and, as a result, has no unfavorable effect on property tax and capital gains tax. In addition, this deed is straightforward and low-cost.
The major drawback of a TODD is that title companies are reluctant to issue title insurance for three years after the owner’s death. This, in effect, prohibits the new owner’s sale or use of the real property as loan collateral for three years. Another drawback is that a TODD cannot provide a contingency if the intended heir dies before the owner.
Another viable alternative is a trust. The problems with a trust, is the cost and probably more importantly, its complexity. Trusts are not easy to understand and require transfer of real property to the trust. This requirement of trust ownership is often overlooked which results in probate administration. But a properly funded trust allows for contingencies, avoids probate, is private and has favorable property tax and capital gains treatment.
To sum it up
The unintended consequences of adding a co-owner to real property are; unfavorable tax treatment, exposure to the new owner’s creditors, relinquished control to sell and mortgage the real property and failure to transfer due to an unplanned order of death.
Viable alternatives to joint tenancy are Transfer on Death Deeds (“TODDs”) and revocable living trusts. But TODDs are new and not fully tested. Trusts are complicated but when properly funded avoid probate, are private, do not create unfavorable tax consequences and the owner maintains control of the real property.
Mark W. Bidwell authored this post. Mr. Bidwell is an attorney located in Orange County, California. Telephone is 714-846-2888. Email is Mark@DeedandRecord.com