BENEFIT TRADE-OFFS IN PROPERTY TITLING
Many married couples hold most, if not all, of their property as tenants by the entirety. Couples are often unaware of the alternative methods of property titling, as well as some of the trade-offs involved in selecting a particular form of holding property.
Each form of property ownership has specific implications, and, when assessing a method, the benefits gained must be balanced against the benefits lost.
There are four primary ways to hold property:
In your own name. Anyone may choose to own property in his or her own name. Owning property outright gives the owner complete control over the property, but such property is generally included in the owner’s gross estate for estate tax purposes and usually has to pass through the probate process.
As tenants in common. This method allows two or more parties to own property together, with each owner maintaining the right to sell his or her interest without the consent of the other co-owner(s). Generally, such ownership interests must be bequeathed through a will and do not pass automatically to the co-owner(s) at death. Consequently, such property typically is subject to probate.
As joint tenants. Also called joint tenancy with right of survivorship, this form of ownership provides each “tenant” with an undivided interest in the entire property. An owner may not sell without the consent of the other co-owner(s). If one owner should die, the surviving owner(s) automatically inherits the decedent’s interest (i.e., the property passes “by law” and does not go through probate). Caveat: A creditor may force the sale of such held property to satisfy the debts of only one owner.
As tenants by the entirety. This is a special form of joint tenancy solely for married couples with one significant difference: The property cannot be sold to satisfy the debts of one of the owners.
Consider Simon and Ellen who have two college-aged children, Andrea and Jason. Life has been good to the couple, and they have built an estate worth $10.68 million, with all of their assets jointly held as tenants by the entirety. (For the sake of simplicity, we will not consider retirement plan assets, which cannot be held jointly.)
While on vacation, Simon and Ellen are involved in a fatal accident. Simon dies instantly; Ellen lives for four days and then dies. In this unfortunate set of circumstances, what are the estate tax implications for their jointly held $10.68 million estate?
At Simon’s death, his interest in all jointly held property automatically passes to Ellen free of Federal estate taxes by virtue of the unlimited marital deduction. For the four intervening days that Ellen is alive, she is the sole owner of the previously joint $10.68 million estate. At her death, $5.34 million of the estate would be offset by her 2014 applicable exclusion amount. Because all property was jointly held, Simon’s $5.34 million exclusion amount was lost. Failure to plan for Simon’s exemption ultimately decreased the amount passing to Andrea and Jason.
“Bypass” to a Solution
Had Simon and Ellen “equalized” their estate (i.e., each owned $5.34 million outright), each could have set up a bypass trust with $5.34 million. In this example of nearly “simultaneous” deaths, the assets in Simon’s bypass trust would pass to the children free of estate taxes (the $5.34 million exemption offsets the assets in the trust). Since Simon died first, Ellen’s bypass trust effectively terminates. When Ellen dies four days later, the assets that were in her bypass trust would also pass to the children free of estate taxes because of her $5.34 million exemption. With equalized estates, $10.68 million (in 2014) can pass to the children free of Federal estate taxes.
Now the “trade-off” may be apparent. By owning their property as tenants by the entirety, Simon and Ellen achieved creditor protection (remember, for a married couple who title assets this way, a sale cannot be forced to satisfy one spouse’s debts), but they also exposed their joint estate to the possibility of higher estate taxes. On the other hand, had they chosen to minimize estate taxes (Ellen and Simon each making use of their $5.34 million exemption), the property that each held outright (or as tenants in common) might have been exposed to claims by creditors.
Consult and Assess
The hypothetical example of Simon and Ellen demonstrates one of the dilemmas of property ownership: if you want maximum estate tax reduction, you usually must sacrifice maximum creditor protection, and vice versa. How important is creditor protection? It depends. Unfortunately, there are no easy answers in this area of estate planning. However, examining the trade-offs involved in using various forms of property ownership may be a good first step toward developing a strategy that most benefits your family. In addition, be sure to check with your attorney for applicable state laws concerning methods of property titling.