Frequently, our attorneys are asked to draft a real estate deed to establish a joint tenancy with full rights of ownership to the survivor of the two or more owners (Jointly Owned Real Estate). The reason to do so is usually to avoid probate while also avoiding the use of a trust to transfer the ownership of the real estate from the older generation to the next generation. Can this be done? If it’s “legal,” why isn’t everyone doing this? Is this expensive?
Yes, it is lawful to create Jointly Owned Real Estate to avoid probate and to avoid having to use a trust to transfer ownership of the real estate described in that deed. However, doing something that is lawful does not by itself mean it’s a good idea. Let me explain below.
Frequently, the person who is the sole owner of the real estate and asking us to draft a deed to establish Jointly Owned Real Estate is a parent (or grandparent, uncle, etc.) and the real estate is the person’s Homestead. The parent is usually a widow or widower. At the parent’s death, the parent wants the Homestead to be transferred to the younger generation without the time or cost of probate and without having to create a trust. Because the parent is usually not receiving any money or money’s worth to establish the Jointly Owned Real Estate; it is considered a gift because no money or anything else of value was given to the parent in consideration for establishing the joint ownership.
To answer the last question above – “Is it expensive?” – the first response might be “no.” When compared to the cost of probate or the cost of creating and funding a trust, the cost to draft a deed is inexpensive. But, that’s not the whole story. There is much for the real estate owner to know and understand before signing a deed to create Jointly Owned Real Estate to avoid probate and avoid setting up a trust.
Below is a list of possible issues to be discussed with your attorney so the real estate owner makes an informed decision whether to create Jointly Owned R. E. to avoid probate without the use of a trust. The list below is not in order of importance. All are important! Any of the items below may have significance for some but not everyone. Depending on circumstances that may arise later, after the gift (the deed) is given, and for which the parent will have no control without careful planning done before the gift (the deed) is given. The words “real estate” and “property” when used below have the same meaning as Jointly Owned Real Estate.
1. Capital Gain Tax; Loss of Step-Up in Basis. Capital gains tax is tax imposed on the profit from the sale of property or an investment. Basis is the amount of your capital investment in that property. Since capital gains tax is applied to the difference between what you paid for the property or investment, i.e. your basis, and what you sell the property or investment for, you can see how one might benefit from a higher basis (higher basis means less profit means less tax).
When a person dies, the value of their property receives a “step-up” in basis. This means the person receiving the decedent’s property takes it at a basis equal to the fair market value of the property on the date of the decedent’s death. However, when a person gifts property, or even a portion of that property, during their lifetime, the step-up in basis is lost because the person who receives the gift (the donee) takes the basis of the person making the gift (the donor). Losing the ability to step-up the tax basis of property may have little to no consequence if the property’s value experienced little to no market appreciation.
Consider this scenario – If non-homestead property was purchased at $100,000, that is the property’s basis. If the property is improved (beyond regular repair and maintenance) with adding another room or a pool for example and the improvements are $50,000, the adjusted basis would be $150,000. If you then sell the property for $200,000, and assuming you had ownership of the property for more than one year, the long-term capital gain tax would apply at the then current rate on the gain of $50,000 ($200,000 sale price – $150,000 adjusted basis = $50,000 gain). Even at a ten percent (10%) capital gain tax rate, there would be a tax of $5,000. The same tax effect would occur if the property was gifted to another (original basis would carry over) and then sold by the donee. If such a gift had not been made during the donor’s lifetime, but instead was made after the donor’s death by will or trust, there would be a step-up in basis to the fair market value as of the date of death, which results in zero ($-0-) capital gain tax if the property is sold shortly after the death.
2. Joint Tenants with Rights of Survivorship as an Estate Planning “Technique.” Using a joint tenancy with rights of survivorship may not work as effective estate planning. It may work to avoid probate when the first joint owner dies but probate is not automatically avoided for the surviving owner. The last of the joint owners must take affirmative action to avoid probate concerning that property (i.e. transfer that property to a trust or into another joint tenancy). If probate is not avoided and the last of the joint owners dies without a will, that real estate will be probated using Florida’s intestate succession laws to transfer ownership. It is rare when the intestacy laws transfer ownership in the way the deceased owner would have wanted.
3. Incapacity or Unwillingness of the Other Joint Owner. All joint owners must sign and deliver a deed to transfer jointly owned real estate to a third party. One joint owner alone cannot transfer the real estate. If any of the joint owners becomes mentally incapable of consenting to the sale or transfer of the property, or is otherwise unwilling to consent, the options for sale or transfer are limited. Those options consist of not selling or transferring the property, petitioning a court for relief, or waiting for that incapacitated or unwilling joint owner to die, hopefully before you do. One reason you and any joint owner should coordinate your respective estate planning is to have durable powers of attorney to avoid incapacity issues. With a willing but incapacitated joint owner, a previously executed durable power of attorney would allow the incapacitated joint owner’s agent to consent to the sale or transfer.
4. Creditor Issues; Bankruptcy. Florida homestead property is exempt from being available to satisfy the debts of its owners, except for liens for taxes, mortgages, and work performed on the property. If the property is not Florida homestead, it does not have the same creditor protection.
5. Other Joint Owner’s Divorce. If the other joint owner is married and later is involved in a divorce, the interest of the other joint owner may be part of the marital estate to be dealt with between the parties or the divorce court. Therefore, if the other joint owner is contemplating marriage, it would be wise for that person to have a prenuptial agreement that speaks to what happens to the property in case of divorce. There is no guaranty that the prenuptial agreement may be honored by a divorce court or that the estranged spouse of the other joint owner will be cooperative.
6. Homestead Real Estate Tax Exemption; Save Our Homes Real Estate Tax Cap. The Florida Constitution limits annual increases in the assessed value (not the taxes) of homestead property to three percent (3%) or the CPI whichever is lower if you maintain your Homestead Exemption. This is the Save Our Homes (SOH) cap.
Below comes directly from the Pinellas County Property Appraiser’s web site about adding another person as an owner to one’s homestead concerning SOH:
If the new owner is a joint tenant with right of survivorship, and he or she DOES NOT apply for Homestead Exemption, your SOH cap WILL NOT be adjusted.
If the new owner is a joint tenant with right of survivorship and DOES apply for Homestead Exemption, your SOH cap WILL be adjusted to market value and start anew the following year. In future years, the SOH Cap will protect 100% of the property.
One Important Note! If the new owner is living with you and intends to make the property his or her permanent residence, it may make more sense to apply for the new Homestead Exemption now rather than waiting until a later date. Your Homestead Exemption and SOH cap protects only you, and not the new owner. In the future if you no longer reside in this home, the new owner will have to apply at that time, and the property value and taxes will most certainly be much higher than they are now.
7. IRS Gift Tax Return. When a person transfers property to another (except for their spouse) while receiving nothing or less than full value in return, the IRS defines this as a gift and requires filing a gift tax return if the value of a gift is over $14,000 (under current law) in any calendar year. You would not have to pay a tax when the gift is made or with filing the gift tax return. The value of the gift over the $14,000 annual gift tax reporting exemption will reduce the donor’s federal estate tax exemption available to their estate at their death.
Consider this scenario – If you transfer half of your property valued at $100,000 to another person, that would be a gift valued at $50,000. Therefore, a gift tax return would be due for the year in which the gift was completed and your federal gift and estate tax exemption would decrease by $36,000 ($50,000 gift – $14,000 exemption = $36,000). The current gift and estate tax exemption is $5.45 million. If your total estate is significantly less than $5.45 million and you make a few gifts over $14,000 in any one year to any one person, the outcome will likely have little effect, meaning federal estate tax will not be an issue of your estate.
There are ways to lawfully avoid filing a gift tax return and avoid the reduction of your lifetime federal estate tax exemption while still effecting your desired transfer. One way is to make the transfer in stages to avoid having to file a gift tax return with the IRS (i.e. make annual gifts in amounts under the annual gift tax exemption until the desired transfer is complete).
8. Refinance of the Real Estate. The credit worthiness, or lack thereof, of the other joint owner may have a negative impact if you later want to use the real estate as collateral for a loan. At the very least, a lender will want the other joint owner to sign the mortgage even if the other joint owner is not a signer on the promissory note secured by the purchase money mortgage. This is another example of why coordinated estate planning is recommended for joint owners. A durable power of attorney that explicitly states the agent will cooperate with the other joint owner in the sale or refinancing of jointly owned real estate is cogently recommended.
9. Asset Protection. Having a joint owner on Florida non-homestead real estate potentially exposes the real estate to satisfy the claims of the other joint owner’s creditors, at least for that person’s ownership interest. If the real estate becomes homestead property, there may be no problems during your lifetime. However, if the real estate will be refinanced and the other joint owner is dealing with a credit problem, bankruptcy or divorce, any such problem may be an obstacle to closing a sale or the refinance of that real estate. Remember, a person’s homestead in Florida is protected from the claims of third party creditors except for liens for taxes, mortgages, and work performed on the property.
10. Long-Term Care Planning. If you later require long-term care, talk with an attorney that provides Medicaid planning services or obtain long-term care insurance. If one qualifies, government assistance to finance long-term care is provided through Medicaid and possibly other government-sponsored agencies. Owning non-homestead real estate jointly may be an obstacle to doing proper and timely long-term care planning. If the real estate is homestead, a non-spouse sharing ownership may provide an obstacle for payment through Medicaid or another government-financed program.