March 5, 2007

JOINT TENANCY: AN ESTATE PLANNING TOOL TO CONSIDER?

Many people hold property through joint tenancies to try to minimize the tax and administrative costs of probate. This form of ownership can be a useful tool, as it provides for equal ownership of property between joint tenants, with ownership of the whole transferring automatically to the surviving tenant(s) upon the death of one. Cal. Probate Code ¤ 223. Property that can be held through joint tenancies include real property, as well as bank accounts, mutual funds accounts, certificates of deposit and other types of financial assets. Whether or not a joint tenancy is the right form of ownership for particular individuals, however, depends both on the relationship of the parties seeking to establish a joint tenancy, and the characteristics of the joint tenancy: the assets in question, the source of the funds used to acquire the assets and, with respect to financial assets, who controls the funds and how they are used.

First, the relationship of the parties involved can make a difference in whether a joint tenancy in fact exists, regardless of title. In particular, while married individuals can hold property in joint tenancy, such property is, in California, presumed to be community property in a marriage dissolution or separation proceeding. Cal. Fam. Code ¤ 2581. This presumption can only be rebutted by a clear statement in a deed or other documentary evidence that the property is separate property or proof that the parties have a written agreement that the property is separate property. Id.

Second, the characteristics of a particular joint tenancy (the type of asset and how it is funded and used) can affect how it is treated for tax purposes: if not structured correctly, it may trigger immediate tax liability. Under IRS rules, any transfer of property, real or person, tangible or intangible, would create a gift tax situation. See Treas. Reg. ¤ 25.2511-1. Thus, if one person acquires an asset and establishes a joint tenancy with another, then half the value of the asset is considered a transfer to the co-tenant Ð and will be subject to a gift tax on any amount over the annual gift tax exclusion ($12,000 in 2006). There are differences, however, in when and how a transfer is triggered as between real property and financial assets.

With a joint tenancy involving real property, the IRS will consider the transfer to occur as soon as the joint tenancy is established Ð and will tax accordingly. (In accord with California family law, the IRS will not treat such a joint tenancy created by a husband and wife as a taxable transfer. Treas. Reg. ¤ 25.2515-1.)

Financial assets are treated similarly, with a key difference: while the IRS views a real estate transfer as occurring immediately upon creation of the joint tenancy, it will not do so with certain financial joint tenancies, including joint savings and checking accounts and other joint investment accounts, such as mutual fund accounts. In such cases, the IRS will look to whether the person creating and funding the account maintains control over the account. If that person can regain the entire fund without the co-tenant's consent, then no transfer has occurred. A transfer will occur, however, when and to the extent that the co-tenant draws on the account's funds (subject to the applicable exclusion amount).

In short, holding property in joint tenancy can be a useful estate planning tool. It is important, however, to keep in mind the tax consequences of establishing and funding a joint tenancy. As noted above, real estate held through a joint tenancy will be subject to gift tax to the extent that the co-tenants contribute disproportionately to the acquisition (unless the joint tenancy is community property). Financial assets will be treated similarly unless the tenant contributing the greater amount maintains control over the "excess" funds and until the additional co-tenants draws on them. At the same time, such accounts allow, through the annual gift tax exclusion, for the gradual, tax-free increase in funds.

ADDITIONAL INFORMATION

For additional information on joint tenancies or assistance estate planning, please contact either Larry Inouye or Colleen Sechrest either by telephone (310.712.0100) or email: linouye@shiotani-inouye.com or csechrest@shiotani-inouye.com.