After a decade of preparing and administering hundreds of estates for clients and their families, I have observed several common mistakes in estate planning. For example, many people assume that because they hold all their assets in "joint tenancy" with their spouse or with their children, their estate planning is done. That is because the joint tenant has access to the asset already and it automatically passes on death to the surviving joint tenant. What many Californians don't realize are the potential side effects of Joint Tenancy ownership:
A) Capital Gains Tax Exposure. When a married couple own real estate as community property in California and one of them dies, then the surviving spouse enjoys a full step-up in the cost basis at the moment of the first death. That means that if the surviving spouse sold the house at that moment, no capital gains tax would be due at all. Capital Gains tax is roughly about 25% of the gain (the difference between what you paid for the house and any major improvements and the sale price). This is not the case if you hold the property as joint tenants. Joint Tenants only enjoy a one-half step-up in basis at the first death and have to wait until the second death to receive the full step-up in basis.
B) Creditor Exposure. Some people add their children to their deeds prior to death as joint tenants to avoid probate. They don't realize that as a new owner, their child's creditors can make claims against the home. For example, if the joint tenant ran a red light an hit a bus load of lawyers, a lawsuit exceeding the driver's insurance limits would soon follow. As bankruptcy followed the lawsuit, so could your home.
C) Death Out of the Usual Order. One person I met put her son on the deed to her home before going into surgery. She did not just add him as joint tenant, but gave him the entire home. After she came out of surgery, she found out her son had passed away unexpectedly. Her son, like most Californians, had no will. The home passed to her two minor grandchildren whose mother then evicted her.
D) Death at almost the same time. Sometimes we die within a short time of each other because we are in a mutual accident. The heirs of the person who survives the other inherits the asset regardless of how unfair that may feel to the other person's family. This usually results in litigation. For example, husband and wife die within a several days of each other. Wife survives longer. Wife's family inherits the entire home. Husband's family gets nothing. The worst part, however, is that the asset then goes to probate, since both joint tenants are deceased.
E) Gift Taxes. When you add someone other than your US Citizen spouse to title on your assets, the IRS assumes you have made a gift. Currently, you can only give $13,000 to one person per year. Any gift above that must be reported to the IRS on a gift tax return each year. Each person is allowed to gift only a certain amount in their entire lifetime. Starting in 2013, that amount will be $1 million (unless the law changes). If your gifts exceed that amount, then a tax would be due at about 50-55%. These gifts are also deducted from the $1 million you are allowed to pass at the time of your death. This means that those who inherit from you may pay tax at 50-55% for the gifts you make today.
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