Forms of Property Ownership

In the U.S., property may be owned in several different ways:

1. sole, outright ownership, also called "fee simple"

2. joint tenancy with rights of survivorship

3. tenancy by the entirety, which also has rights of survivorship

4. tenancy in common

5. partial interests such as life estates and remainder interests

6. community property.

Methods 2-6 are forms of co-ownership among two or more people.

The form of property ownership is very important in estate planning. It determines how and to whom the property passes at the death of an owner, and the extent to which the value of this property is included in the deceased owner's gross estate for federal estate tax purposes. While joint ownership is often looked upon favorably--especially by spouses--it can cause some estate planning problems.

Sole Outright Ownership

A person who owns property solely and outright enjoys the full rewards--and responsibilities--of property ownership. He or she is entitled to any income that the property earns, and is entitled to sell it and reap the entire gain (if any). On the down side, the sole owner must pay any taxes levied on the property, any debts against the property, any expenses related to the property (repair, renovation, maintenance, etc.), and bear any loss if the property is sold after it declines in value.

Joint Tenancy with Rights of Survivorship

In a joint tenancy with rights of survivorship, two or more persons own property jointly, and all owners hold an equal interest in the property. The property may be real estate or any kind of personal property.

The magic words, "with rights of survivorship," must be used on the deed or other evidence of title when the co-ownership is created.

Sample language: "to Bob Jones, Carol Jones, Ted Smith and Alice Smith as joint tenants with rights of survivorship"

What if the magic words were omitted? The state laws vary but, in most states, a tenancy in common is the usual outcome. Lawyers often say that the law does not favor the creation of joint tenancy with rights of survivorship, and if that's what the owners want to establish, they must explicitly demonstrate their intent by using the "magic words."

Can an owner dispose of his interest in joint-tenancy-with-rights-of-survivorship property by will? No, that would undo the whole idea. The property passes automatically to surviving co-owners at an owner's death, and the decedent's will has no effect upon the transfer.

Can an owner get around the restriction on wills by disposing of his or her joint interest during life? Generally, yes. In some states, he or she does not even need the consent of the other owners to do so. However, such an action will terminate the joint tenancy, and convert it into a tenancy in common.

Tenancy by the Entirety

A tenancy by the entirety may only exist between spouses, and only in certain states. Like the joint tenancy with rights of survivorship, tenants by the entirety enjoy the right of survivorship. When one spouse dies, the other becomes the sole, outright owner of the property.

And also like the joint tenancy with rights of survivorship, while both spouses are alive, each owns an equal interest in the property. This is an important point. In our society, wives are often younger than their husbands, and women as a group have a longer life expectancy than men. However, the law does not require us to go through some complicated actuarial calculation that might try to assign more than 50% of the interest to the wife because of her greater statistical likelihood of survivorship.

But here the similarities with joint tenancy end. Neither spouse can transfer his or her interest in the property during life without the consent of the other spouse. Recall that joint tenants with rights of survivorship often do not need the consent of the other owners.

Also, tenancy by the entirety is generally not treated with prejudice by the law as joint tenancy with rights of survivorship generally is. In most states that recognize tenancy by the entirety, when title to property is taken by spouses, the law presumes a tenancy by the entirety has been created. To eliminate all doubt, the magic words in the deed or other instrument of title transfer should be explicit. Click here for typical language.

Tenancy in Common

A tenancy in common may exist among two or more co-owners, the same as joint tenancy with rights of survivorship. However, a tenancy in common is unlike a joint tenancy in two key respects:

1. there is no right of survivorship when one co-owner dies, and

2. the co-owners may hold unequal interests in the property.

Thus, when a tenant in common dies, the ownership percentages do not change for the survivors. Instead, the deceased owner's interest passes to some new party under his will, or under the state intestacy laws if he dies without a will. As you might expect, a tenant in common may also freely transfer his or her interest in the property during life without the consent of other owners.

To use a computer analogy, tenancy in common is the "default setting" in most joint ownership situations. If one tries to create a joint tenancy with rights of survivorship or a tenancy by the entirety but fouls it up in some way, the usual outcome will be a tenancy in common.

Partial Interests in Property

Interests in property may be sequenced in time. For example, one individual may own a life estate in property, which gives her the right to possess and enjoy the property for as long as she lives. Another individual may hold a remainder interest in the same property, which gives him the right to possess and enjoy the property after the life estate terminates at the life tenant's death. The life estate is a present interest; the remainder is a future interest.

A reversionary interest is a right to get property back upon the occurrence of some contingency. For example, mother might give Blackacre to son, with the proviso that she will get the property back if son predeceases her.

The IRS issues valuation tables to apportion the full value of property among the holders of partial interests, based on actuarial factors and an assumed interest rate.

Community Property

There are nine community property states: Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington and Wisconsin ("marital property"). Puerto Rico also has community property laws. These laws differ from state to state.

"Community property" only exists between spouses. The term refers to property acquired during marriage in which each spouse is deemed by law to own 50%. It does not matter which spouse actually purchased or earned the property. However, property brought to the marriage by either spouse generally remains the separate property of that spouse. Also, property received by gift or inheritance after marriage is generally separate property.

When a spouse dies in a community property state, his or her 50% of the community property is usually disposed of under the will (or the intestacy laws). It does not pass automatically to the surviving spouse. However, it is possible in some states to have property titled as "community property with right of survivorship."

How Property Is Transferred

Title to property may be transferred or exchanged by sale or exchange, gift, will, law, or contract.

Sale or Exchange

Property may be sold for cash or other property. If the seller receives fair market value for the property, this transaction generally has no estate planning consequences. One asset simply takes the place of another in the owner's estate.

Gift

When property is transferred by gift, there is a reduction in the size of the former owner's estate. This will tend to keep the estate in a lower estate tax bracket when the owner dies.

When an owner tries to keep some kind of string on the gift property, he can lose the estate tax benefits. At death, the IRS may treat owners as if they had never made a gift of the property. Some of the prohibited strings are the right to get the property back, the right to the income from the property, and the right to continued possession or enjoyment of the gift property.

Even if these strings are avoided, a portion of the value of the gift property may figure into the estate tax calculation at death as an "adjusted taxable gift." These will generally be gifts to someone other than a spouse to the extent that such gifts exceeded $10,000 per donee, indexed for inflation, per calendar year when made.

Will

Property that a decedent owned solely and outright at the time of death may pass under his will, if he had one. The will gives a person the opportunity to spell out his or her specific plans for the distribution of assets after death. Assets passing under the will are often referred to as the probate estate. To the extent assets pass outside the will--for example, life insurance proceeds payable to a beneficiary other than the estate--they "avoid probate."

Law

If a person dies without a will, the state intestacy laws will control how the estate assets are distributed. Essentially, state law "writes a will for you," but it probably will not be what most individuals would have wanted. Clients should always be encouraged to record their wishes regarding distribution of assets in a will. The joint tenancy with rights of survivorship and tenancy by the entirety are other cases in which the property avoids probate and passes by law to the surviving co-owner(s).

Contract

When an insured dies, the insurer has a contractual obligation under the policy to pay the death proceeds to the designated beneficiary. Unless the beneficiary is the insured's estate, the proceeds will pass outside the will by contract. Another example would be death benefits payable under an employer fringe benefit program such as a qualified retirement plan or a deferred compensation plan.

Taxation of Jointly Owned Property

General Rule

The entire value of joint tenancy with rights of survivorship property is generally included in the gross estate of the first to die. However, the amount included in the gross estate of the decedent will be reduced by the consideration furnished by the surviving joint tenant. For tenancy in common or community property, only the decedent's fractional interest in the property is includible.

Special Rule for Spouses

Only 50% of the value of property held by spouses as tenants by the entirety or joint tenancy with rights of survivorship is included in the gross estate of the first to die. The consideration provided by each spouse toward the purchase price is not taken into account. However, in nearly all states, the surviving spouse receives a stepped-up basis for income tax purposes in only the 50% of the property included in the deceased spouse's gross estate.

Joint Property Planning

Joint tenancy with right of survivorship (and tenancy by the entirety) can cause a number of problems for the property owners in the estate planning process. Some individuals treat joint tenancy with rights of survivorship as a substitute for a will because joint tenancy with rights of survivorship property avoids probate. Where the estate exceeds the applicable exclusion amount sheltered from federal estate tax by the applicable credit amount, or the spouse does not want the burdens of managing property, an alternative to joint tenancy with rights of survivorship may be advisable.

Joint tenancy with rights of survivorship (and tenancy by the entirety) substantially limits estate planning flexibility. Full ownership is vested automatically in the survivor, which may not be advisable, depending on the type of property involved, if the survivor lacks the experience, expertise or inclination to manage the property.

Joint tenancy with rights of survivorship (and tenancy by the entirety) may also result in overqualification for the estate tax marital deduction. Too much property will pass to the surviving spouse, and is likely to be taxed at her later death. Such overqualification could be avoided, in some cases, if the joint tenancy with rights of survivorship is broken up and a bypass trust is used to provide benefits for the survivor without tax consequences at her death.

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