Avoiding Probate is a major consideration that people must consider when discussing the passing of assets from one generation to the next, particularly due to tax consequences and Liability issues.
Periodically, grown children of seniors will suggest that the parent add the childrens names to the title on the parents home. The idea is that the children would become joint tenants with the parent so that the home wont have to go through probate when the parent passes away.
Joint tenancy is a form of ownership of property that permits the surviving joint owner to receive the share of a deceased joint owner automatically.
For example, if a parent were to enter into a joint tenancy with her son, he would become the full owner of the property at the parents death. Because the property passes automatically, the son would avoid having to take the home through probate, and would most likely save a great deal of money in probate fees. All the son would need to do is have an Affidavit of Death of Joint Tenant drafted and recorded with the County Recorder, and the title would be held solely in his name. However, it is good practice to avoid this kind of an arrangement, for several important reasons:
Tax Consequences: When two people buy property together as joint tenants, the amount of money they invest in the property is called their basis in the property. A propertys basis is exempt from capital gains taxes at the time of sale. If somoene bought a home many years ago, that persons basis in the property might be quite low. In many areas, despite the recent downturn in the economy, a property that was purchased many years ago for $150,000 may easily be worth three times that today.
When a person receives property from a deceased person, the recipient usually gets to take whats called a step-up in basis. That means that the propertys basis is raised to the fair market value at the date of death of the deceased person. If the recipient were to sell the property immediately upon receiving it, that person would not have to pay any capital gains taxes on the property. In effect, all the accumulated value in the house over the years would be received by that person tax-free.
When two parties enter into a joint tenancy, however, half of the benefits of the step-up in basis are lost. The survivor will receive the step-up in basis on your half of the property, but retains his basis (zero) in his original half. If the deceased joint tenant bought the home for $100,000, and the survivor sells it for $500,000, he will receive a step-up in basis of $300,000 (the decedents original investment of $100,000 plus $200,000 for the decedents half of the appreciation). The survivor may be able to take clear title to the home without problem, but when he goes to sell the home, he may find himself with a hefty capital gains tax bill. For people who own significantly appreciated property, a joint tenancy with their children is almost always not a good idea.
Liability Issues: Most people who put their childrens names onto the title of their home do so with the intention of eventually passing that home to their children when they pass away. What many of these people fail to realize is that putting a childs name on the deed passes title to the property now. The new joint tenant would become an immediate co-owner of the home. This creates a great deal of risk, especially for older people who have paid off their homes and live on retirement income.
Suppose a senior puts her son on her home as a joint tenant, and two years from now the son gets in a car accident and is sued. The senior may find that her home becomes the central asset in a battle to collect a judgment against the son. The same problem can arise if the son loses his job and has to declare bankruptcy. His creditors would see that he is a half owner of the home, and might try to force a sale to recover their money. If the child owes back taxes to the government, then the house is an available asset. The same goes for child support and other obligations.
In short, a joint tenancy with children is not the safest or best way to pass property to the next generation of a family. Although it is probably the simplest and cheapest way to avoid probate, the hidden costs can be astronomical. For individuals and families who are seeking ways to avoid probate, it is generally advisable to set up a revocable trust. A trust permits a person to pass property to his or her children quickly and easily, without the hassle of probate and its attendant fees and time delays.