Basic Legal Principles

In order to understand Estate Planning, you should have a basic understanding of principles of ownership and property. Following are some important legal principles with which you should become familiar. Some may have no immediate application to your life, but over the coming years you may find it very valuable to have this information at your disposal. 

When title to property is in one person's name, the law regards that person as the sole owner. Any other person claiming rights to that property has a steep uphill battle to establish such a claim. The person who is named on the document of title - a deed, pink slip or even a sales receipt - is presumed to be the owner for all purposes.

The named owner has the exclusive rights to sell or transfer the property. Upon the death of the named owner, it will pass to the people named in the owner's Will or, in the absence of a Will, to the owner's heirs. Any tax deductions related to the property will be limited to the named owner.

Where two people pool their income and purchase an item with money from that common fund, you should make certain that any document relating to the item of property reflects your dual ownership. It is unwise to depend upon private assurances between the two of you that are different from the written statements of ownership. Don't rely on verbal statements or your "understanding" or assumptions.

When you own items of property jointly, it is called a joint tenancy. This is a unique form of ownership and can be a useful tool of financial planning, but must be approached with caution.

• Rights of Joint tenants

Each joint tenant enjoys complete and full rights of ownership. Either can sell the entire property without the permission of the other (although you will find few buyers willing to take the risk), even though you would both be entitled to share equally in the proceeds of the sale.

You own what is known as an "undivided joint interest" which gives you extensive rights to occupancy and decision-making regarding the property. Either one of you could occupy the property to the exclusion of the other.

If one joint tenant dies, the other automatically becomes the sole, full owner. You cannot pass your joint ownership interest by Will. Since this is even more extensive than the rights married couples have in their community property, joint tenancy is to be entered into only after considering all its ramifications.

• Obligations of Joint Tenants

Each joint tenant is fully liable for any debts secured by or connected to jointly owned property, whether he or she had anything to do with the creation of the liability or not. Each joint tenant is responsible for the maintenance of the item of property, whether the other one contributes or not. As far as the law is concerned, joint tenants are considered to be one person and completely interchangeable for most purposes regarding liability to the outside world.

• Inheritance for Joint Owners

On the death of one joint tenant, her or his interest immediately ceases to exist. Therefore, the surviving joint tenant is the only owner. That means that one joint tenant cannot will his or her interest to someone. There is nothing to pass by Will.

This is one of the major features of joint tenancy from an estate planning perspective. Since title to the interest of the deceased joint owner passes by law to the surviving joint owner, there is no need to put the property through probate. This will save you probate fees and possibly attorneys' fees as well.

Upon the death of one joint tenant in real property, the survivor merely needs to file a declaration and record it to transfer title in most states. If you have a joint bank account, the survivor is entitled to immediate and uninterrupted use of the account, although banks will require you to complete a form when one joint tenant dies.

• Taxes With Joint Ownership

Upon the sale of jointly owned property, each of you will be responsible for income taxes on any resulting net income. Each of you is fully obligated for any property taxes connected with the property. If you are subject to inheritance taxes you should seek the advice of a tax professional regarding the taxation of jointly owned property. 

See the comparison below of joint tenancy and tenancy in common.

• Some Special Issues with joint ownership

One of the features of joint ownership is that either joint owner can end it. A joint owner can convert title to the property to tenancy in common by recording a deed transferring title from oneself as a joint tenant to oneself as a tenant in common under the law in California and some other states. You should seek legal advice in this regard if the need arises.

The advantage of this is that if the two of you wish to end your relationship but retain ownership in the property, either of you can protect your rights by recording a deed. Each of you would then be equal co-tenants and could, for practical purposes, control the sale of the property as well as limit your liability with respect to the property.

Where two people want to establish shared property rights, tenancy in common is probably your best bet. When you own property as tenants in common, you can establish your respective rights as either equal or unequal. For example, if one person pays twice as much of the property payments as the other, you may want to reflect this fact in the title to the asset.

You can place title to real or personal property items in both names to result in equal ownership rights as follows:

"John Jones and Bruce Williams as tenants in common"

Or, you can specify ownership shares, as follows:

"John Jones as to an undivided 3/4 interest and Bruce Williams as to an undivided 1/4 interest, as tenants in common"

This will result in John owning three-fourths and Bruce owning one-fourth of the item of property.

Such flexibility is often important as a way of expressing your financial relationship.

•  Rights of tenants in common

Each owner of a tenancy in common has the right to occupy and use the item of property. This right does not permit the exclusion of the other tenant in common, however. Neither owner can force the other to sell the property except through a court order. However, either owner can sell his or her rights in the property without the approval of the other.

Owners can dispose of their ownership interest in the property by Will. Absent a Will, their interest will pass by law to their heirs under the law, which usually does not include the co-owner (a good reason why you will want to complete your own Will and/or revocable Trust).

• Obligations of tenants in common 

Each tenant in common is responsible for liabilities connected with the property to the extent of their ownership interest. For example, where you buy a house or condo and take title as tenants in common, a 3/4 interest to one and a 1/4 interest to the other, claims against you as owner of the property will reflect the same ratio. Of course, if you sign for a debt related to the property, whatever terms are specified in that document prevail.

For practical purposes, however, remember that if one of you defaults on a secured debt, the other is going to have to find a way to pay both shares if she or he wants to maintain ownership of the property that secures the debt. As a result of paying more than your share, there may be rights of repayment between you, but as far as your lender is concerned, they just want the payments.

Should there be a loss connected with the item of property, such as an injury for which the property owners are liable, both of you will be liable for the loss to the same extent that you hold ownership rights.

Personal liability is different, as, for example, where you drive a car owned by both of you-you are personally liable for the full amount of damages caused by your accidents. Both of you also may have liability in that case as owners of the car, to the extent of your ownership interest.

• Inheritance by Co-Tenants

As indicated above, one tenant in common has no rights of inheritance in the interest of the other tenant in common (co-tenant). Where you own an item of property as co-tenants and you want your interest to go to your partner upon your death, you will need to take care of that in your Will or revocable Trust.

• Taxes Among Co-Tenants

Any income earned in connection with property owned by co-tenants, such as on the sale of the property, will be subject to income tax in proportion to the respective ownership interests. Income generated as a result of personal effort, however, will be taxed entirely to the person expending the effort. If you are in doubt about any of this or wonder how it might apply to you, your best bet is to see a tax or legal professional.

Property taxes are apportioned in the same ratio as the ownership interest, although once again, both will want to make sure the full taxes are paid to protect your interest.  Again, see our the discussion below for more information.

• Joint tenancy vs. Tenancy in common

Joint tenancy

·         Immediate transfer upon death

·         IRS presumes survivor paid for it all, difficult to challenge

·         Then no “basis” increase on first death

·         If couple owns jointly and separates, property may pass to wrong person

 Tenancy in common

·         Each owns their share

·         Each can give their share on death as they desire

·         Tax basis increase on death for portion owned by deceased owner

·         If couple separates, each has legal right to pass their share to who they wish

What happens when joint property is  then sold?

·         Property was purchased in 1990 for $500,000

·         For tax purposes, this is known as the “basis”

·         Property is sold after the death of the first joint tenant this year.

·         The tax on the sale of the property is the “gain”, or difference between the basis and the sale price

Tax treatment of sale after distribution

Joint tenancy

·         Basis - $500,000

·         Sale = $800,000

·         No increase in basis on portion of first to die, so entire gain will be taxable to survivor

·         Taxable Gain is $300,000 to survivor

 Tenancy in common

·         Basis - $500,000

·         Sale = $800,000

·         Basis step up to $400,000 (1/2 sale price) for portion of first to die

·         Gain is for the survivor is only $150,000 for portion held by survivor

Revocable Trust

In recent years many attorneys have recommended to their clients that they create what is known as a "revocable, or living trust" as a part of their estate plan. This advice is pertinent to single persons, married couples and unmarried domestic partners.

The revocable trust is an agreement whereby you transfer all or part of your property to a trust and become the trustee(s) (operators, managers) of the trust property. For the most part this merely entails a bit of extra paperwork and the normal day to day activities are unchanged.

One of the primary advantages of a revocable trust is that it allows for the transfer of property upon the death of the trustor(s) (persons who create the trust) without going through probate. Instead, the trust document itself provides for what is to happen upon death. Unlike a Will, which must be approved by a court before it has legal force and effect, a revocable trust is like any other contract agreement and needs no court approval or processing.

If for some reason it becomes important to have court supervision over the distribution of property from a revocable trust, it is possible to bring a proceeding for that purpose.

Normally you would transfer title to all your assets to the trust. This might involve pink slips and other such transfer documents. There may, however, be situations where you want to keep certain assets out of the trust. If you have a question about this, we suggest you discuss it with an attorney. In most cases, there would be no transfer fees or only minimal fees since this is not a sale but only a change in form of ownership.

There are specific steps that you must take to make the transfer effective. If you do not take these steps, your revocable trust will be useless. Refer to the Revocable trust page for further information.

Charitable Giving

In these times of government cutbacks, there is a need for private funding of worthwhile community activities. Often these activities do not receive favorable treatment from public agencies or private foundations. 

What many people are not aware of is the opportunity to use estate planning devices to both care for the living and provide for charitable organizations. While many people with sizable estates (over the $3.5 million limit) utilize charitable giving to minimize estate taxes, those with smaller estates should consider this area as well.

It is possible to provide for gifts in a revocable trust or a will to a charitable organization. You may wish to consider leaving part of your estate to a charitable organization after both of you die if you are a couple. For many of us, the community is a very real part of our "family" and this becomes a natural bequest.

It is possible to utilize life insurance policies to both maximize the amount given and do so at very low cost. For example, a life insurance policy given to a charitable organization and paid for by you can generate both an income tax deduction for you and a large endowment for them.

Other devices, such as charitable trusts can be utilized to provide for lifetime benefits for you and your loved ones and gifts to charities after your death. This topic is complex and beyond the scope of this Guide, but we urge you to contact professionals and charitable organization's planned giving departments for further information.

Other Issues

Following are other issues that are related to your estate planning needs.

• Partnerships, Corporations

There are situations in which the formation of a partnership or a corporation would be advisable. If you have questions about this area, you should obtain legal and tax advice.

• Bank accounts

One technique for the transfer of assets is through bank accounts. You can put your funds in a joint account with another person and upon your death, that person will have the right to the funds in that account. this is a specialized form of joint ownership. For tax purposes, all those funds will be regarded as included in your estate, however.

Another method of using a bank account to transfer assets is to establish an account for the benefit of another person. In the law these are known as "Totten" trusts. For example, an account "Mary Smith for the benefit of "Nancy Jones" can be managed by Mary during her lifetime and the funds would go to Nancy upon Mary's death. Again, these funds will be included in Mary's estate for estate tax purposes.

• Insurance

Life insurance policy proceeds are not subject to probate except where you name your own estate as the beneficiary. The purchase of a policy of life insurance, therefore, can allow for the transfer of substantial amounts of money without the need to pass it through probate. These funds are usually available fairly quickly in contrast to property in probate.

Life insurance proceeds will usually be included in determining the size of your estate for estate tax purposes. For example, if you own a life policy that pays a $500,000 benefit, that will be added to your gross taxable estate. Therefore, if you have other assets worth $150,000, your estate would be subject to estate taxes.

If however, you neither own the policy nor have any means of exercising control over it, the policy will not be included in your taxable estate. For this reason, some people purchase a life insurance policy on their life, transfer ownership over it to another person, and then make annual gifts of the amount of the premiums on the policy. This will effectively transfer substantial assets upon death without either probate or estate taxes.

There are a wide variety of forms of life insurance on the market today and you may want to investigate your options as a part of an overall financial plan.

Additionally, life insurance policies may provide for current income to you now if you are disabled with AIDS. There are a number of companies that will in effect buy out the policy's benefits to provide you with cash now. Most insurance companies will do this as well.

• Gifts

Especially where you face life-threatening circumstances, a gift to people you would want to have a particular item or a certain amount of money after your death may be appropriate before you die. Property transferred by gift avoids probate. A gift does not, however, remove the transferred asset from your estate for tax purposes.

Remember to do anything needed to complete the gift. This may mean formally transferring title by deed, pink slip or other means. At the very least, It means relinquishing control over the item to the person you are giving it to. Where no document of title is needed, write out a letter indicating the specific things being given and have it notarized if possible.

Note that there may be tax consequences connected with gifts. Gifts in excess of $13,000 per person per year require a federal gift tax return. Gifts during your lifetime in excess of $13,000 per person per year are accumulated for purposes of determining the $1.2 million  threshold for estate tax purposes. This can be, however a viable means of distributing one's estate and avoid probate.

When combined with insurance policies, it can provide for a very large tax-free gift. For example, if you purchase a policy of insurance on your life, the value of it is normally included in your taxable estate, whether you pass the proceeds through your Will or not. However, if you transfer ownership of the policy to another person, and retain no ability to change beneficiaries or otherwise control the policy, it will not be part of your taxable estate. You can then make a gift each year of the amount of the premiums to the person to whom you gave the ownership of the insurance policy. Then, upon your death, that person or the beneficiary of the policy will get the value of the policy tax-free.

See an insurance specialist, attorney or financial planner for more information about how this can work for you.