Estate planning is a critical aspect of securing your financial legacy, and among its various components, property ownership stands out as a foundational yet often overlooked consideration. Properly aligning asset ownership with your estate plan can make or break your intended objectives. It’s not enough to have a well-crafted estate plan; the way you own your assets and how they are transferred both play a vital role in the successful execution of your wishes. In this guide, we’ll delve into various types of ownership and their implications in estate planning, while considering income tax, gift tax, and estate tax considerations.
Summary and Takeaways
The crucial role that property ownership plays in U.S. estate planning is often misunderstood and overlooked – and the type of ownership can significantly affect such things as state and federal taxation, claims from creditors, and whether the property is subject to probate. But there are ways to leverage particular types of ownership, as well as strategic transfers of property to others, in order to minimize future tax liability. The appropriate proactive approaches to estate planning can also help ensure the optimum value for loved ones who are your designated beneficiaries.
Key Takeaways
- Solely-owned property can be gifted to others during your lifetime, but upon your death the gifts are subject to probate, creditor claims, and taxes.
- With joint tenancy with the right of survivorship, ownership passes to the surviving joint tenant, bypassing probate, but may be subject to creditor claims.
- Spouses may use tenancy by the entirety to ensure protection from creditors and that the property passes to the surviving spouse.
- There are many estate planning options, each with potential pros and cons. It is highly recommended that a qualified estate planner familiar with all the options be consulted to ensure proper planning and desired outcomes.
Overview: The Significance of Asset Ownership
Asset ownership is the cornerstone of estate planning, influencing how property is transferred and the coordination of your estate planning endeavors. It’s crucial for financial planners to comprehend the intricacies of property ownership and its connection to asset transfer. The form of ownership determines how property can be transferred at death and what limitations may apply. Effective estate planning requires harmonizing both asset titling and property transfer strategies.
A financial planner’s understanding of income tax, gift tax, and estate tax implications is critical. Leveraging suitable asset ownership techniques alongside prudent income, gift, and estate tax strategies creates an efficient estate plan aligned with your unique estate objectives.
Sole Ownership: A Simple Approach
Sole ownership is the most straightforward form of property ownership. It grants the owner absolute control over the asset during their lifetime and upon their death – assuming that the necessary estate documents are in place. This type of ownership conveys outright control, allowing for gifts and bequests. However, assets under sole ownership are susceptible to creditor claims, which is an important consideration. Solely owned assets become part of the owner’s gross estate and must undergo probate upon death.
Income Tax Implications
With sole ownership, all income generated from the asset is attributed to the owner and reported on their federal and state income tax return(s).
Gift Tax Implications
An individual can gift solely owned assets to individuals or charities during their lifetime, subject to gift tax rules.
Estate Tax Implications
Upon death, the full fair market value of the asset is included in the owner’s gross estate and is subject to probate. However, probate is bypassed if a “will substitute” is employed. Generally, an asset receives a step-up in basis to its value on the date of the owner’s death, unless the six month alternative valuation date is utilized.
Tenancy in Common: Shared Ownership
Tenancy in common involves co-ownership of the property where tenants own undivided rights. Each tenant possesses a fractional interest, and ownership can be equal or unequal. Tenants in common retain control over their fractional interest and can transfer it as gifts or bequests. However, it might be more challenging to sell or transfer fractional interests.
Income Tax Implications
Income is attributed and taxed based on each individual’s fractional ownership share.
Gift Tax Implications
Converting individual ownership to tenancy in common or making gifts of fractional interests triggers gift tax considerations.
Estate Tax Implications
Upon death, the decedent’s fractional interest in the property held as tenants in common is included in their estate. The fractional share receives a step-up in basis.
Joint Tenancy with Right of Survivorship: Joint Ownership
Joint tenancy with the right of survivorship grants co-owners undivided rights to enjoy the property. Upon a joint tenant’s death, their interest automatically passes to the surviving joint tenants. This type of ownership bypasses probate but may interfere with specific estate planning goals.
Considerations During Lifetime
Joint tenants can sever ownership or transfer their interest, but sales or loans against the property require consent from other joint tenants. Creditors can reach a joint tenant’s interest.
Considerations at Death
Upon death, a joint tenant’s interest passes directly to surviving tenants, bypassing probate. However, it might not align with the decedent’s estate plan. There can also be liquidity challenges for the decedent’s estate.
Joint Tenancy with Right of Survivorship with Spouses
When spouses jointly own property, each spouse’s interest is presumed to be equal, regardless of their contribution. This form of ownership differs from joint ownership between non-spouses.
Income Tax Implications?
Jointly owned asset income is attributed equally for married couples filing jointly.
Gift Tax Implications
Transferring property to joint tenancy between spouses who are U.S. citizens triggers the marital gift tax deduction.
Estate Tax Implications
One-half of the property’s value is included in the decedent spouse’s estate, subject to the marital deduction. Any mortgage on joint property affects estate tax.
Joint Tenancy with Right of Survivorship with Non-Spouses
All joint tenancies, whether between spouses or non-spouses, involve equal ownership among joint tenants.
Income Tax Implications
Income from jointly held property is distributed equally among joint tenants, facilitating income splitting.
Gift Tax Implications
Converting individual ownership to joint ownership triggers taxable gifts.
Estate Tax Implications
The Internal Revenue Code states that the value of a decedent’s gross estate shall include the entire value of the property that the decedent held at the time of their death, with two exceptions:
- The joint property holder (survivor) contributed to the purchase of the property
- The decedent and the remaining joint property holder(s) received the property by inheritance or gift
This means that the entire fair market value of the property will be included in the first decedent’s estate, unless it can be proved that the surviving owner contributed to the purchase of the asset. This is known as the Contribution Rule, which applies only to property owned jointly with non-spouses’ right to survivorship.
Tenancy by the Entirety: Spousal Co-Ownership
Tenancy by the entirety applies exclusively to spouses, offering protection from creditors’ claims. Tenancy by the entirety is similar to joint tenancy. It ensures the right of survivorship between spouses with respect to income, gift, and estate tax considerations. When one spouse dies, the property owned as tenants by the entirety automatically passes to the surviving spouse. One-half of the value will be included in the decedent’s gross estate, subject to a marital deduction in the decedent’s estate. The surviving spouse will receive a step-up in basis on one-half of the value of the property.
However, unlike a joint tenancy with the right of survivorship, while both spouses are alive and married to each other one spouse cannot terminate a tenancy by the entirety without the consent from the other spouse. The advantage of this type of ownership is that the creditors of one spouse cannot attach the other spouse’s interest in the property. This is in contrast to joint tenancy with the right of survivorship, where a creditor of one owner can attach the debtor’s interest in the property. Although a lien can be attached to property held as tenants by the entirety, a creditor cannot force liquidation of the property, and any claim against the property can only be satisfied when the property is sold.
Life Estates and Remainder Interests: Split Ownership
Split ownership divides the property into a life estate (temporary ownership during the lifetime) and a remainder interest (ownership after the life estate ends).
Life Tenant’s Interest
Life tenants retain usage rights and responsibilities for the property. The remainder interest is protected from creditors.
Remainder Beneficiary’s Interest
Remainder beneficiaries have vested ownership but can’t claim full ownership until the life tenant’s death.
Income Tax Implications
Life tenants report income from the asset, while remainder beneficiaries report income upon receiving property.
Gift Tax Implications
Gifts involving life estates and remainder interests entail taxable gifts. The annual exclusion can be used to offset the value of the taxable gift for the life tenant However, the annual exclusion will not be available to offset the gift of the remainder interest, because a remainder interest is a future interest in the trust.
Estate Tax Implications
If someone creates a life estate for themselves, and they retain the right to the property until death, the fair market value of the property will be included in their gross estate at death. The remainderman will receive a full step-up in basis of the property upon the life tenant’s death.
If someone instead receives a life estate and they do not have any control over the disposition of the asset at their death, the value of the life estate would not be included in the life tenant’s gross estate at death. The remainderman will still receive a full step-up in basis of the property at the life tenant’s death.
| Ownership Type | How Passed at Death? | Included in Probate? | Included in Gross Estate? | Qualifies for Marital Deduction? | Beneficiary Cost Basis |
|---|---|---|---|---|---|
|
Sole ownership |
Will/intestacy |
Yes – 100%, unless designated beneficiary |
Yes – 100% of FMV |
If passed to a qualifying spouse |
FMV at death or Alternative Valuation Date |
|
Tenants in common |
Will/intestacy |
Yes – % owned, unless designated beneficiary |
Yes – % of FMV owned |
If passed to a qualifying spouse |
% of FMV at death or Alternative Valuation Date |
|
Joint with spouse |
Operation of law |
No |
Yes – 50% of FMV |
50% of FMV |
50% of FMV at death or Alternative Valuation Date + Beneficiary’s basis |
|
Joint with non-spouse |
Operation of law |
No |
Yes – 100% of FMV (unless can prove the other joint tenant contributed) |
No |
% of FMV at death or Alternative Valuation Date + Beneficiary’s basis |
|
Tenants by the entirety |
Operation of law |
No |
Yes – 50% of FMV |
50% of FMV |
50% of FMV at death or Alternative Valuation Date + Beneficiary’s basis |
|
Create a life estate |
Automatically to the remainder beneficiary |
No |
Yes – 100% of FMV |
If passed to a qualifying spouse |
FMV to the remainder beneficiary |
|
Receive a life estate |
Automatically to the remainder beneficiary |
No |
No |
No |
FMV to the remainder beneficiary |
Navigating the various options of property ownership is essential in creating an effective estate plan. Each form brings distinct tax considerations and implications that can significantly impact your financial legacy. To make more informed decisions, consult with your financial planner at Cardinal Point and estate planning professionals who can guide you toward strategies that best align with your particular goals.