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Disadvantages of Joint Tenancy for Married Couples

How do you own your home? If you are married, chances are that like most married couples you own your home as joint tenants with your spouse. Why do so many of us own our homes and other property in joint tenancy, and what are the disadvantages to this common form of ownership?

To start, it’s important to understand what joint tenancy is. Take a look at the deed you received whenever you and your spouse bought your home. It probably lists the names of you and your spouse followed by “as joint tenants with rights of survivorship” or similar language. When property is owned in joint tenancy, both owners have co-equal ownership; that is, each owner has the right to use and occupy the entire property. This is obviously desirable for married couples. In addition, joint tenancy is good because it avoids probate on the death of the first spouse to die: the property automatically passes to the surviving spouse without court intervention. However, there are a few important reasons why you may not want to own your home in joint tenancy.

First, as we’ve discussed, joint tenancy can serve as a probate avoidance tool. Yet, probate is only avoided on the death of the first spouse to die. Upon the death of the surviving spouse, the estate of the surviving spouse must go through the probate process. If you have children, this will cause delay in transferring the property to them or distributing the proceeds of a sale. What’s more, probate can be expensive: your children might have to pay an attorney several thousands dollars to complete the probate case. Finally, should the surviving spouse get remarried and transfer the property to the surviving spouse and his or her new spouse as joint tenants, the children could be unintentionally disinherited.

Another disadvantage of joint tenancy is lack of asset protection. If you and your spouse have a revocable living trust, you can design it so that the property you leave to your children is protected from the claims creditors and ex-spouses. With joint tenancy, as soon as both you and your spouse pass away, your children receive the property outright, creating the possibility a child could lose their inheritance in the event of a lawsuit against that child.

Lastly, there is a major tax disadvantage to joint tenancy. Under the federal tax code, inherited property is entitled to what’s called a step-up in basis. To illustrate this concept, imagine that Tom bought a house in 1980 for $100,000. Tom died in 2014. By this time, the house had increased in value to $200,000. For federal capital gains tax purposes, the cost basis of Tom’s heirs in the home is $200,000, i.e. the current fair market value of the house. Practically speaking, this means if Tom’s heirs immediately sold the house for $200,000, they would not recognize any gain for federal tax purposes and would not owe any federal capital gains taxes on the sale. In contrast, if Tom’s heirs did not get a step up in basis, their cost basis in the house for federal capital gains tax purposes would be the price Tom originally paid for the house — $100,000 — and not the current fair market value of $200,000. Consequently, Tom’s heirs would owe federal capital gains taxes on the difference between the $100,000 purchase price and the $200,000 sale price.

What does this have to do with joint tenancy, you ask? The federal tax code allows joint tenants only 50% of the stepped-up basis. Let’s return to the example above. Assume that Tom was married to Cindy and they owned the house they bought in 1980 for $100,000 as joint tenants. Fast forward to 2014, the date of Tom’s death. Only the 50% interest that passed to Cindy upon Tom’s death would get the stepped-up basis. The basis for the 50% that Cindy already owned would be unchanged. As a result, Cindy’s basis in the house would be $150,000. Supposing Cindy sold the house, she would owe federal capital gains taxes on the difference between the $200,000 sale price and her basis of $150,000. Depending on Cindy’s tax bracket, this could result in significant taxes.

As you can see, there are many issues inherent in joint tenancy ownership. While it might not be right for everyone, a revocable living trust can get around many of these issues, and is definitely worth exploring with an estate planning attorney.