Joint Tenancy- The Wrong Way to Leave an Inheritance to Your Children

Estate Planning including wills, trusts, and other documents allows for you to leave an inheritance for your children. Unfortunately, there are many misconceptions on how that can be done. One of those ways is Joint Tenancy.

If you set up a trust, you can put your property into a trust. However, some people name their children as joint tenants on their properties instead. They are attempting to keep their property out of probate. When one tenant passes on, the other half is meant to go to the joint tenant. However, there are some issues with this and most of them have to do with taxes and creditors.

Creditors and Joint Tenancy

If you or your children have debts, the debtors can collect on the home. One may be punished for the other’s debts. There are situations that you may not foresee when setting up the joint tenancy, such as divorce, lawsuits, or bankruptcy. They can even force a sale on the home. Your child may end up paying for your debts with the property and not receiving her full inheritance. Unfortunately, sometimes a child dies before a parent and the parent is stuck paying for debts with the property.

Capital Gains Taxes and Joint Tenancy

Another downfall with relying on a joint tenancy to give your child an inheritance is capitol gains taxes. When you sell your property, you are taxed with a capitol gains tax. That means that you pay a tax on the increase in value from when you first acquired the property. Often times people hold on to property for several years without selling the property. With time the property usually significantly increases in value. You will then have to pay property gains tax on the amount that the property increased in value.

However, if the property had been put in a trust, the capitol gains taxes can be decreased significantly. This is because when property is put in a trust, the basis for your heirs is “stepped up” to it’s value at the date of your death. This makes it so that there is not such an increase in the value, which allows you not to have to pay as much in capitol gains taxes.

Giving an Inheritance to Children Here is an example of using a trust to avoid capitol gains tax. Let’s say you bought a home back in 1996 for $120,000. The market was down and you got a great deal. You put the home in a joint tenancy with your child. You pass away in 2016 and your child does not live near the home and does not have the means to take care of the home. She decides to sell it and the selling price is $420,000. She will then have to pay capitol gaines tax on the increase in value, which would be $420,000-$120,000 which =$300,000. If you had put that same home in a trust, the capitol gains tax basis is the value of the home at the time of your death. So, if that same home that you bought in 1996 for $120,000 was worth $410,000 at the time of your death in 2016, your child only has to pay capital gains taxes on $420,000-$410,000, which equals $10,000. A $10,000 capital gains tax as opposed to a $300,000 capital gains tax assists in your child receiving more inheritance from you.