Almost all homes, as well as other assets, owned by spouses in California are held in joint tenancy. Joint tenancy is a form of ownership where everyone on title owns 100% of the subject property. Generally speaking, as people die, the "last man standing" is the individual who will own the asset outright. Because nothing formal needs to be done, for many people this looks like a nifty way to avoid a California probate as well as the need for estate planning in California. Pretty smart right? Well, not exactly …
While it's true that joint tenancy might avoid a probate and could alleviate the need for some estate planning, everyone should understand the risks involved with holding Joint Tenancy assets, especially in California. Some of the risks are obvious while others are shockingly subtle. Below, I've grouped the risks into three major categories, starting with some of the more well known problems and then discussing some of the less obvious fiascos that California joint tenancies create:
Problem # 1 – Who will be the ultimate owner of joint tenancy assets?
Most of the time, the "final" owner of joint tenancy property is a spouse (when title is solely held by a husband and wife). But after both spouses pass away, the question remains: who inherits then? If no estate planning is carried out before the death of the surviving spouse, joint tenancy assets will pass through "intestate succession" (ie how the State of California guesses you would have wanted it to pass). If you have the "Wally Cleaver" family this may not be an inheritance problem, per se, because the asset will be split and eventually distributed to the children of both husband and wife. Of course, there will likely be a long and costly probate court proceeding to make that happen but at least the assets wind up in the "right" hands.
So under the best case scenario, assets might pass the way parents want, but it will cost a significant amount of money and take (typically) one to two years in California. But what happens if we tweak the facts a little and / or the family dynamics are not perfect?
Answer: All sorts of wild things. And how often do these problems really occur? Answer: A lot.
For example, if a child predeceases a parent in California, and that parent held her house in joint tenancy with her son and daughter, that asset will end up 100% in the hands of the other surviving child, while cutting out the grandchildren of the first predeceased child. Most parents cringe at the thought of unintentionally cutting out legitimate heirs.
Another unintentional result occurs when a spouse or child is holding property in joint tenancy and then the child gets sued (because of a car accident, bankruptcy, etc.) and that creditor ends up attaching the property that mom or dad believes they are solely owned. In other words, holding assets in joint tenancy gives potential creditors of your beneficies the right to seize your assets! Obviously, this is a horrible result when it happens.
Actually, what occurs even more often than the "unintentional" transferences mentioned above are the intentional transfers. These occur most often when there are children of a prior relationship involved or a surviving spouse simply getting remarried at some point. In these situations, it is frequently the case that the "survivor" of the original joint tenancy leaves those (joint) assets to a new spouse (It is interesting to note that this could happen intentionally or inadvertently when new spouses create yet another joint tenancy ). Another common result occurs when the survivor of joint tenancy property, leaves those assets to their children from a prior relationship, instead of to your biological children.
Estate planning attorneys are well aware of the problems encountered above because these occurrences happen frequently in California. But what about some of the less obvious problems …
Problem # 2 – Tax Issues!
The interplay between the death and income tax systems is tricky when it comes to how title to property is held. This is especially true in California as well as a few other community property states. You see, when spouses hold property in joint tenancy in California and one of them passes away, there is only a step-up in tax basis on the false persons half of estate assets under IRC section 1014. That means, there is still a lot of potential tax owed by the surviving spouse on those assets. (Conversely, when the same assets are held in a living trust in California, there is a 100% step-up in tax basis on 100% of all capital assets owned; meaning there will be no tax owed when a surviving spouse goes to sell them.) Sometimes couples who held real property in joint tenancy are "saved" by IRC section 121 for quick sales of a principal residence-this is the potential exemption available when people live two out of the past five years in their home. In these situations, the survivor can get a $ 250,000 step-up in tax basis. However, this safety net only applies to a principal residence and not any other assets (ie, a second home, stock, etc.). But oftentimes, even with the possibility of using both IRC sections 121 and 1014, there is still not enough to save a surviving spouse from crushing taxes.
To illustrate the problem above, I will tell you about a real life example of a person who got used in the crosshairs of a California joint tenancy, lack of a stepped-up basis and large capital gains taxes. In this persons case, along other assets, he and his wife held two homes in joint tenancy. She passed away in January of 2014 and he sold one house in late 2014. He also had the second home up for sale in 2015 because he could no longer live there. Prior to filing his 2014 tax return, he decided to set up a California living trust. Through this process, the difference between tax basis, California community property ownership, joint tenancy ownership, and his current tax ramifications were explained to him. As the realization set in that he owed an intense amount of tax – tax that was totally unnecessary to trigger – he was not happy, to say the least. The reason he now owed extra tax was because he and his wife bought both properties for relatively little and held them in California joint tenancies. Upon her passing, her half of the properties were stepped-up, while his half was not. On the first sale, even with one-half of each home receiving a stepped-up basis, the sale of his half of the home created a huge tax burden for him. He was able to use his IRC section 121 exclusion to help make up some of the difference and that definitely helped. But even with the half step-up in basis, plus his $ 250,000 IRC section 121 exclusion, he still owed quite a bit of tax. To make matters worse, he could not live in the second home and if he went through with his proposed sale, he was going to face even much worse tax ramifications. So, instead of paying tens of thousands of dollars of yet even more tax, he was forced into holding the second home (and paying property taxes, insurance, upkeep, etc.) for a minimum of two more years in order to hopefully capture another IRC section 121 exclusion. And he was lucky! Had he not quickly consulted with a tax professional, he would have additionally lost out on the second exclusion. Please note that all of this may be a bit confusing but the point is that if he and his wife had not held the properties in California joint tenancies, and instead, held them in a California living trust, he would have owed zero tax. But in an effort to save a few dollars on estate planning, these joint tenancies in California cost him dearly.
Amazingly, the problem would be much worse if a parent (instead of spouses) tried to use joint tenenses instead of a trust in California because almost 100% of the time, the protection afforded under IRC section 121 would not be available. Still, the issues caused by California joint tenancies in these first two categories of problems pale in comparison to the dilemmas that arise in the following situations …
Problem # 3 – The minority, yet HUGE elder law issues which California joint tenancies cause.
This category of problem is especially noxious both because few people understand the relationship between California joint tenancies and California elder law, and also because of the extent of damage that that lack of knowledge causes. You see, in the past, most people have been focused on the question of what happens to their stuff when they die, while completely ignoring the question of what happens to their stuff if they live?
What's the difference? Confused? Why does it matter you ask? Answer: It matters because in California, seniors can receive Medi-Cal or Veterans Pension Benefits (under the right circumstances) to pay for long term skilled nursing care. And receiving these government benefits just might stop of bankruptcy. But for those who failed to do any estate planning and are holding onto joint tenancies, government benefits may not be available.
In order to understand why the above is true, it's important to understand California elder law. California elder law however, is extremely complicated. But again, a real life example can help explain the elder law / joint tenancy issues more clearly. In this case, a wife and her husband held their primary home in joint tenancy in California. They also held all of their liquid accounts in joint tenancy. And in addition, they recently began construction of a retirement home, which they held (you guessed it) in joint tenancy. The joint tenancies seemed like a good transfer plan to them, until the husband suddenly and out of now suffered a debilitating brain injury. After months in the hospital (which Medicare covered), the hospital kicked him out and into skilled nursing care. The cost of skilled nursing was, and is, $ 880 / day. Although the first few days were covered by Medicare, some simple math revealed that in less than four years both husband and wife would become bankrupt. What's worse, is that none of them had any estate planning in place. This means that she had no authority to do anything with his half of their assets. Furthermore, because the houses are held in joint tenancy, she can not do anything meaningful with her half of those properties! That's because she simply has no authority to act for him, which as a consequence of joint ownership means that she also has no power over her half as well. (In theory, she could try to sell her half, but who is going to buy of of a house?) Thus, as long as the homes remain jointly owned, she has no ability to control the economic value of the homes. Thus, she is unable to borrow against the home (s) if a loan is required for their maintenance and support (or, in this case, for the retirement home to be fully built in the first place). And she is unable to sell either home to raise funds to pay for the care her husband so desperately needs (not to mention future care that she may need).
If they had had their assets in a trust, or at least, had had really good elder law powers of attorney, she could now do protection planning for their assets and in the process avail her husband of Medi-Cal (California's version of Medicaid) . But they did not do that and can not now do it, after husband's brain injury. Thus, those California joint tenancies literally left her in quicksand. Put another way, she can do nothing but let the half-built house rot, while her husband is stuck in expensive skilled nursing care.
But there must be some solution you wonder? Well, sometimes people will petition a court under a "3100 Petition" to beg a judge to let her "gift" his half of the assets to her, to help them both stave off bankruptcy. But there is no guarantee that a judge will rule in her favor. In fact, in Los Angeles where she is located, there is a good chance that a judge will not allow her to do this. Judges in Los Angeles are simply not so sympathetic to these situations.
So what are her options? She can do nothing and if she dies before him (the result that nobody ever thinks of, but happens sometimes), the family assets will be 100% his (under joint tenancy law) and it is likely that their entitlement estate will end up paying for his care, leaving nothing to show for a lifetime of hard work. On the other hand, if he dies first, she will be able to do some planning after the fact, but she will face all the same tax issues above as well as possibly being stuck with his large medical bills.
Since the aforementioned cases are pretty horrible, if her 3100 Petition is not approved, she will be forced into petitioning for a regular probate court conservatorship for her husband. This should allow her to get out of the quicksand and act (a little). But the problem is that simply opening a conservatorship will not allow her to effectively preserve family assets. In other words, in this situation, she is looking at hundreds of thousands of dollars wasted, both in terms of lost Medi-Cal as well as conservatorieship legal costs.
Any way you slice it, her joint tenancy assets are going to cost her dearly. The only question is to what extent the damage will be? This is the reason older law and joint tenancies in California are especially dangerous. At least in the first two categories above, just a persons heirs hopes are programmed. But in these elder law situations, California joint tenancies could literally leave their owners broke!
The moral of the story: if people engage in regular estate and elder law planning, instead of trying to avoid planning by using California joint tenancies, they can achieve all their goals without losing part, or all, of their assets to taxes and long term care costs.