It is very common for spouses to title property that they own together as "joint with right of survivorship." When one passes, the other owns the property outright. It’s simple, easy, and automatic. But it gets messy when the other joint owner isn’t your spouse.
Have you ever considered owning property jointly with a child or other family member, a friend, or a business associate? Adding another person as owner of a vacation house, recreational boat, or bank account may seem like a good idea. However, this may cause negative consequences such as loss of control, unknown creditor issues, and tax consequences.
Loss of Control
Once you co-own an asset with another individual, you enter into a legal ownership agreement known as "joint tenants with rights of survivorship." When one of the owners passes away, the surviving owner automatically becomes sole owner of the property.
When you own property in this manner, you forgo a certain amount of control. For example, you may want the portion of the property that you own to go to a child or other person and even indicate your wishes in your will or other estate planning documents. Unfortunately, ownership title takes precedence over your estate documents allowing the surviving owner to become sole owner.
Let’s assume that you inherited a lake cabin from your parents with the intent that the property be shared with your brother. As a result, you title the property jointly with your brother. Even though your will document states that all your assets should be divided equally between your son and daughter, if you die before your brother, your share of the cabin will become your brother’s. Your son and daughter would inherit no interest in the cabin.
Another way control is lost is the ability of a non-spouse owner to transfer his or her interest in the property to another individual without your consent. For example, your brother has the ability to sell his interest in the cabin without your knowledge or approval.
An additional consideration when contemplating a joint ownership arrangement with a non-spouse is the fact that it can be very challenging to remove a co-owner from the property title without full cooperation from him or her.
Another danger of jointly held property is the exposure of the asset to the creditors’ claims of both owners. Let’s assume your brother, as a co-owner of your cabin, runs into financial difficulties and files for bankruptcy. His ownership in the cabin may be claimed by a creditor or forced to be sold to pay off debts. Unless you have the funds to buy his ownership in the cabin, you may now own the property with a total stranger!
Or, if your brother’s marriage goes bad resulting in divorce, a judge may decide that the ex-wife should receive an interest in the property. You would now own a cabin with your brother’s ex-wife.
Potentially Higher Taxes
Although adding a non-spouse person as co-owner of an asset allows for simple property transfer at your passing, it could also result in both gift tax and increased capital gain tax.
By adding a non-spouse person to the title of an asset, you are making a gift to the new joint owner. Depending on the current value of the property being gifted, you may be liable for gift taxes.
Capital gain taxes can be increased for heirs of the property. Property transferred at death receives a step-up in basis. This means that the heir’s cost basis is equal to the fair market value of the property at your death and not your cost basis, e.g. the amount you paid for the property. Receiving a step-up in basis reduces the heir’s capital gain on the appreciation of the property when sold. However, if you add a co-owner, only your interest in the asset has the benefit of stepped-up basis at your death and not the entire property. This may cause higher capital gain tax when the property ultimately is sold.
The cons of holding joint title with a non-spouse many times outweigh the pros. Loss of control of the property, becoming subject to the co-owner’s creditors, and potentially higher taxes can be negative consequences. Because property ownership is so important to your overall financial planning, be sure to discuss these issues with a qualified advisor before taking action.
Contributions were made to this article by Abby VanDerHeyden, a CFP candidate and Financial Planning Coordinator at Bedel Financial Consulting, Inc.
Elaine E. Bedel, CFP, is CEO and president of Bedel Financial Consulting, Inc., a wealth management firm located in Indianapolis. She is a featured guest each Wednesday on the WTHR (NBC, Indianapolis) Channel 13 News at Noon, “Your Money” segment. Elaine’s book, “Advice You Never Asked For…But wished you had,” is available on Amazon.com. For more information, visit www.BedelFinancial.com or email Elaine at firstname.lastname@example.org.