Most people hold title to their investments in joint tenancy, but this is often not the best way to hold title. To determine how you hold title to your investments look at your title documentation. If you hold title in joint tenancy it will read “John Doe and Mary Doe, as Joint Tenants” or “John Doe and Mary Doe, Husband and Wife, with the Right of Survivorship.” This means the property automatically passes to and becomes owned by the surviving joint tenant upon the death of the other joint tenant.
The reason joint tenancy is such a popular method of holding title to your investments is that it is a simple way to take title and it avoids probate at the death of the first joint tenant. (Probate means court supervision of your estate at your death. Probate is expensive and takes time, so most people like to avoid it whenever they can.) People think they are saving time and money by taking title to their investments in joint tenancy. However, there are some real problems with joint tenancy.
1) Joint Tenancy Does Not Always Avoid Probate
First, joint tenancy does not avoid probate upon the death of the last owner. For instance, if you and your spouse own your investments as joint tenants and you die, the investment passes to your spouse free of probate. However, when your spouse dies, unless she has placed your investment in joint tenancy with others, the property will be probated because there is not a surviving joint tenant. The same is true of bank accounts, stocks and other assets you have placed in joint tenancy. If, on the other hand, these investments were placed in a living trust, you could arrange it so there would be no probate on your death nor on the death of your spouse. Joint tenancy only postpones probate, it does not avoid probate.
2) Your Will Does Not Act On Joint Tenancy Assets
A second problem with joint tenancy is that a joint tenant’s will does not control where the property goes. For example, you may intend to leave everything to your wife, but if you have a joint checking account with your son, then upon your death your son, not your wife, will get the checking account. If your son then gives your checking account to your wife, he will be making a gift and he may have to pay a federal gift tax.
3) Joint Tenancy Often Causes Assets to Disappear
A third problem with joint tenancy is that the property can end up in the hands of beneficiaries to whom you did not intend to leave it. For example, take the investment that went to your spouse. Suppose your spouse remarried and, wanting to avoid probate, makes her new spouse a joint tenant in the ownership of the investments. If she dies, her new spouse gets the investments and your children receive nothing. This is probably not what either of you had intended.
Another variety of this type of problem is the childless couple. Assume that one spouse dies. All of the joint tenancy property goes to the surviving spouse and later if she dies without a will, the property goes 100% to her family. In other words, all of the property goes to the relatives of the last spouse to die, thereby cutting out the relatives of the spouse who died first.
4) Joint Tenancy Can Result in Gift Tax Liability
The fourth problem with joint tenancy is a potential federal gift tax problem. For example, if you put $50,000 of I.B.M. stock in joint tenancy with your son, then you are obviously making a gift. Anytime you make a gift of more than $15,000 per year per individual, you have a possible gift tax liability.
5) Joint Tenancy Is A Death Tax Trap
The fifth problem with joint tenancy occurs when one wants to avoid unnecessary death taxes. Holding assets in joint tenancy causes those assets to pass to the surviving joint tenant rather than into the tax savings trust. By holding title to assets in joint tenancy, you are often incurring unnecessary death taxes.
6) Joint Tenancy is An Income Tax Disaster
The biggest problem with joint tenancy is the income tax problem. This is best illustrated by the following: Suppose you bought stock in 2000 for $50,000 and today it is worth $250,000. If you sold this stock while you and your spouse were both alive, the difference between your cost ($50,000) and your sale price ($250,000) would be $200,000. This $200,000 would be subject to tax at long-term capital gains rates. However, if you held onto that stock until the death of one of you, the tax would depend on how you held title. If you held title as joint tenants, then $100,000 would be subject to long-term capital gains tax because only the decedent’s one-half of the stock would get a stepped-up basis to the fair market value at death. If you held title as community property, then nothing would be subject to capital gains tax, because both halves would get a stepped-up basis to the fair market value at the date of death.
It is important to remember that holding title to appreciated assets as community property, not joint tenancy, will result in a lower income and capital gains tax. You can still avoid probate by putting these assets into your living trust and you can avoid the income tax disaster of joint tenancy by taking title to those assets in community property. In short, you can have your cake and eat it too, if you use the living trust.
In summary, joint tenancy is a death tax trap and an income tax disaster. Joint tenancy should be avoided in most estates.