Continuing on from my last post about community property laws in Idaho, today I’ll look at various types of property ownership and the pros and cons of each. I’m thinking here about how you hold bank accounts, title to real estate, or investment accounts with a co-owner.
In Idaho, it is common to find property (especially real property) titled as “Bob and Sue Smith, husband and wife.” The effect of holding property in that “community property” form is that, upon the death of one spouse, the property will need to pass to the surviving spouse through the probate process. Of course, if the surviving spouse does not do so, there will be no immediate bad consequence — instead, the surviving spouse will learn of the issue if he or she goes to sell the house down the road and will have troubles doing so.
If the co-owners aren’t married, they can create a tenancy in common, simply by virtue of each of them having some ownership interest in the property. Each tenant owns an undivided percentage of the asset equal to however much they contributed to get the asset. As an example, imagine three brothers, Aaron, Bob, and Carl, who buy a house together. Aaron put in $100,000 while Bob and Carl each spent $50,000. Aaron owns 50% and Bob and Carl each own 25%. They all have the right to live in the entire house (absent some other agreement between them). Each tenant can sell or give away his or her percentage of the asset, including transferring that interest at death. (This can result in complicated fractional and fractious ownership situations, where the heirs of Aaron, Bob, and Carl end up as tenants in common, whether they like it or not.)
Another option is called “joint tenancy with right of survivorship” (“JTwRoS”). In this form, again each joint tenant owns an undivided percentage of the asset equal to however much they contributed to get the asset. However, if Aaron, Bob, and Carl title the property as a JTwRoS, if one of the brothers dies, the other two automatically (without probate) get half of the deceased brother’s share. So, if Bob dies, immediately Aaron owns 62.5% and Carl owns 37.5%. This is a nice probate-avoidance method, but obviously only if the brothers intend for each other to inherit their shares.
There is another consequence to JTwRoS. At death, any assets owned by a person received a “step-up” in tax basis to the value at the date of death (meaning the new owner of the property does not have to pay capital gains tax if he or she promptly sells the property). In a JTwRoS, even if the joint tenants are married, the property will likely only get a step-up in basis on the portion owned by the tenant who died. In Aaron, Bob, and Carl’s situation, their cost basis is $200,000. Imagine that, when Bob dies, the house is now worth $300,000. Only Bob’s 25% gets a step-up, so the new basis is $225,000. This is generally true even if the joint tenants are married — upon the first death, the property only gets a partial step-up in basis. With non-married co-owners, this step-up in basis problem is not easily solved. However, with married co-owners, it is.
In Idaho, we have a concept called “community property with right of survivorship” (“CPwRoS”). In this form (only available to married couples), you get the best of both worlds — automatic transfer to the surviving spouse without probate and full step-up in basis to the value at the date of death. In order to get that result, the couple must own the property with an explicit designation “with right of survivorship” in the deed.
So what’s best? If you co-own the property with your spouse, you generally want to retain the community property nature of the asset to get the maximum step-up in basis at the first death. If your spouse is going to inherit your half of the property, then “CPwRoS” is the best solution. If for some reason you and your spouse do not intend to inherit each other’s half of the property, then obviously having a right of survivorship doesn’t make sense, and you will probably stick with a community property “husband and wife” designation (or some other system using trusts, etc.). Generally, there is no reason to use a JTwRoS for married couples, and in fact doing so is incorrect because of the risk of losing the full step-up in basis.
Finally, I should mention P.O.D. and T.O.D. designations. “P.O.D.” means “payable on death” and is used with bank accounts, while “T.O.D.” means “transfer on death” and is used primarily with securities. Perhaps Aaron has a bank account in his name, P.O.D. to his brother Bob. While Aaron is alive, Aaron has total ownership over his account and Bob has no right to the money. On Aaron’s death, Bob gets the money automatically, again without probate.
Determining which property ownership scheme is right for you can be a complicated question, involving claims by creditors, inheritance rights, divorce rights, and tax issues. Consult a qualified professional for advice.
