Title held by two or more people in joint tenancy avoids probate because the property automatically passes by right of survivorship to the other joint tenants. Joint tenancy has certain shortcomings. For example:
- If a child becomes a joint tenant with a parent, the parent has made a gift of a one-half interest in the property.
- The property could be subject to the child's creditors. The parent would need the child's permission to change the title back to sole ownership from joint tenancy. Any attempt to change the title back to the original owner may have negative income tax and property tax consequences.
- Income taxes may be due at the death of the parent. After the death of the parent, the child would have to pay one-half of the capital gain on the sale of the property. If the property is not in joint tenancy the child receives the property income tax free.
A major disadvantage for spouses who splitting property hold their property in joint tenancy is the income tax result at the death of one spouse. The surviving spouse receives only a one-half step-up in basis on the value of the property at the death of the first spouse. For example, if the property was purchased as joint tenancy for $50,000.00 and valued at $150,000.00 on the date of death of the first spouse, there would be a $50,000.00 capital gain. The surviving spouse would receive a stepped-up basis for only one-half of the value of the property, or $75,000.00, and would have to pay a capital gains tax on his/her $50,000.00 profit. (One-half the current value of $75,000 less one-half the original purchase price of $25,000.) If the property is held in trust or in community property, the surviving spouse receives a 100% step-up in basis for income tax purposes. If the same property was held as community property for $50,000.00 and valued at $150,000.00 on the date of death of the first spouse, the surviving spouse would receive that property valued at $150,000.00 for income tax purposes. (The basis of the property is stepped-up to the fair market value at death.) The surviving spouse could sell the property with no income tax due. For this reason, spouses should generally hold their property as community property rather than in joint tenancy.