What is the best way to hold a title to real estate? The wrong form of ownership can increase legal liability, enlarge your tax burden and subject an estate to probate. In contrast, choosing the right form of ownership can reduce red tape while improving a property’s profitability.
Holding Joint Real Estate Title
Although property ownership rules vary from state to state, some basic principles apply in most jurisdictions. Below is an overview of some common methods for jointly holding a real estate title, together with their pros and cons:
Tenancy in Common (TIC) — TIC is often employed when two or more owners take title to real estate. This form of ownership is common where the co-owners are not married or have contributed different amounts to the acquisition of the property. One advantage of TIC arrangements is the ability for each party to own a specific, unequal share. When one of the owners dies, that owner’s share of the property passes according to the terms of his or her will or trust. Because a TIC arrangement allows spouses to bequeath their share in a property to children from a prior marriage, this form of joint ownership is also popular among couples in second marriages.
Serious trouble can arise, however, if the inheriting co-owner does not get along with the other owners. An unhappy owner can force the sale of the property whether or not the other owners agree. When an owner files a “partition lawsuit,” the court orders the property sold and divided among the owners. In addition to this disadvantage, TIC arrangements are subject to probate costs and related delays.
Joint Tenancy with Right of Survivorship (JTRS) — JTRS is popular among married couples because it allows husbands and wives to hold title with the right of survivorship, where the surviving joint tenant automatically receives title without the property having to go through probate. He or she needs only to produce a certified copy of the death certificate and record an affidavit of survivorship. The will of the deceased has no effect in such cases, because ownership is conveyed through the title.
JTRS arrangements do not allow for different degrees of property ownership; all tenants hold the same interest. Another drawback is that JTRS allows one tenant to convey his or her share in the property without approval of the others. As in the TIC arrangement, a joint tenant can bring a partition lawsuit and force the sale of a property.
A few states have mitigated these disadvantages by creating a “joint tenant by the entireties” ownership option for married couples. Under this variation of JTRS, spouses cannot transfer ownership of their share without the signature of their marriage partner.
Community Property — Community property laws allow each spouse to own 50% of a property and pass his or her share (through a will or trust) to the designated person of his or her choice. Community property ownership provides a major tax advantage: When one spouse dies, his or her 50% interest is transferred at market value on the date of death, even if it goes to the surviving spouse. This stepped-up basis reduces capital gains exposure when the property is sold.
Couples living outside community property states can still enjoy the benefits of stepped-up basis. To do so, they must hold the property in joint tenancy and acknowledge in writing to each other that the joint tenancy property is also community property.
Community property as a form of ownership is available in ten states and some other jurisdictions (check with your tax or financial advisor for the current list).
What to Do?
Unless you set up a living trust or other property-holding entity (such as a family limited partnership or limited liability company), any property you own jointly will fall under one of the default forms of joint ownership described above. Although joint ownership methods may be fine for holding your residence, they may not be ideal for holding real estate investments. And keep in mind that many real estate professionals own property through limited partnerships, limited liability companies and S corporations — all of which are beyond the scope of this article.
The best advice is to consider the method of ownership before you take title. A bit of planning can go a long way toward saving money and avoiding legal surprises in the years to come.
For assistance choosing the best ownership form for your real estate title, contact Jeff Newman or call your ORBA advisor at 312.670.7444.