Risky: Property Owned with a Non-Spouse
It's very common for spouses to title property 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 can get messy when the other joint owner isn’t your spouse.
Have you ever considered owning property jointly with a family member, friend, or a business associate? Together, you can afford a ritzier vacation house or a bigger recreational boat and share the upkeep. Sounds like a win-win, right? Not so fast! You need to consider the negatives such as loss of control, unknown creditor issues, and tax consequences.
Loss of Control
When you opt to co-own an asset with another individual, you can enter into a legal ownership agreement known as “joint tenants with rights of survivorship” or “JTWROS.” Upon the death of one of the owners, the surviving owner automatically becomes sole owner of the property, whether it’s a vacation home, a plane, or even a bank account.
You relinquish some control of ownership when you own property in this manner. For example, you may want your portion to go to a spouse or a child after your death. But even if you indicate those wishes in your will or other estate planning documents, your co-owner’s ownership title takes precedence over your estate documents. In essence, he or she will become sole owner.
Let’s assume you inherited a lake cabin from your parents with the intent you and your brother would share the property. So, you title the property jointly with your brother. If you precede your brother in death, even if your will document states that all your assets should be divided equally between your children, your brother will become sole owner of the cabin. Your children would be out of luck, unless your brother included them in his estate plan.
But there’s another way you can lose some control over the property. The non-spouse co-owner can transfer his or her interest in the property to another individual without your consent. And be forewarned, it can be challenging to remove a co-owner from the property title without his or her full cooperation.
Another danger of jointly held property is that it’s subject to creditors’ claims against both owners. Using our earlier example, 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 could potentially be claimed by a creditor or he could be forced to sell it to pay off his debts. Unless you have the funds to buy out his ownership in the cabin, you may now own the property with a total stranger!
Here’s another scenario. If your brother’s marriage goes bad and he and his wife divorce, a judge may decide that his ex-wife should receive an interest in the property. You would now own a cabin with your brother’s ex-wife!
Potentially Higher Taxes
Adding a non-spouse person as co-owner of an asset allows for a simple property transfer at your passing. But it could also result in both a gift tax to you and an increased capital gain tax for your heir. The bottom line is that by adding a non-spouse to the property title, you are making a gift to the new joint owner. So, depending on the current value of the property being gifted, you could be liable for gift tax.
Likewise, the heir of the property may have to pay increased capital gain taxes. Property transferred at death receives a step-up in basis. This means the heir’s cost basis is equal to the fair market value of the property at your death - not your cost basis (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 - not the entire property. When the property ultimately is sold, this may create a higher capital gain tax.
JTWROS vs. Tenants in Common (TIC)
When opting to co-own an asset with another individual, you can also enter into an ownership agreement known as “tenants in common” or “TIC.” As discussed previously, holding property JTWROS with another person means when one owner dies, the other owner receives the property outright and automatically. Conversely, when owning property as TIC with another person, when one owner dies, that owner’s heirs would receive his/her share in the property.
Similarly, though, JTWROS and TIC co-owner can transfer his/her interest in the property without your approval as the other co-owner. Again, losing control and potentially putting you in a difficult position.
When entering into property ownership with another party, be sure to consider the pros and cons of both JTWROS and TIC. For most, the cons outweigh the pros. But if owning property with a non-spouse is desirable, be sure to discuss with a qualified advisor all options available to meet your asset ownership and transfer goals as well as any safeguards to mitigate the risks, if possible.