You Might be Avoiding Probate but That’s No Reason to Avoid Estate Planning (Part 1)

Often clients ask whether putting accounts in joint names will avoid probate.  The answer is yes, of course, and many people seem satisfied with the response.  From there, they put everything in both spouse’s names and, sometimes, add their children to their home deed, their bank accounts, and their brokerage accounts.  However, there is a dark side to this type of an “estate plan.”

For one thing, there is still a probate at some point.  One person will be the last to die on the list of “owners.”  When that person does finally die, probate will be required on that estate.  As a result, the better way to phrase it is that the original owner is DEFERRING probate to a later date.

Additionally, when it comes to non-cash assets such as brokerage accounts and real estate, you may end up paying as much or more in capital gains tax by keeping property in joint tenancy.  Property owned by you (or an extension of you, such as a trust) or by you and your spouse as community property gets a full “step up” in basis for tax purposes.  This means that all pre death appreciation is forgiven by the IRS.  So assume, for example, that you purchased a house for $40,000 that is worth $400,000 on your date of death.  Your heirs would receive the property with a basis of $400,000 and would only have to pay tax on the gain if they sold the property for more than that amount.  However, for property owned as joint tenants, the IRS forgives only 50% of the pre death appreciation.  In the exact same situation, if you put your spouse on title for a rental house in order to avoid probate, your spouse would have a basis of $220,000 (50% of the original basis and 50% of the fair market value on date of death).  If she sold the property for what it’s worth, she would have to pay tax on $180,000 in gains.  If you and your family continue transferring property from person to person, keeping track of basis will become increasingly difficult.

While we’re talking about transferring property, putting someone other than your spouse on title to an asset may be a gift according to the IRS.  The IRS has issued a “John Doe” summons for people who have made “gifts” of real property without also filing a gift tax return.  The agency is currently searching property records within the state of California to see if they can find unclaimed gifts.  Although no actual tax is typically due with a gift tax return, it does decrease how much can be left at death without paying a death tax.

Finally, I find that many of my clients have a preconceived notion about who will die first.  A fairly common situation in which an elderly client is ill and decides to put a “child” on title for the client’s house, bank account, and other assets in order to avoid probate and, basically, give the child financial power of attorney.  However, in such a case the “child” is often in his 50s or 60s as well.  Occasionally, the client will outlive the child.  Other times, the child will suffer some catastrophic accident or ailment such as a car accident or stroke that renders the child incapacitated.  Now, suddenly, the client only has control over half her assets and cannot sell the house or close the account.

Do any of the above apply to you?  In the next post, I will talk about even more pitfalls of focusing your entire strategy solely around avoiding probate.  The best way to avoid the unintended consequences is to get started with a comprehensive estate plan.

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