Many British Columbians have been placing assets in joint ownership as a way of avoiding probate. While joint ownership of assets can be useful in some situations, it is often fraught with hidden dangers. This article attempts to dispel some of the many misunderstandings about joint ownership. As well, the article points out some of the dangers of holding property in that manner.
Types of Joint Ownership
There are two types of joint ownership: tenancy in common and joint tenancy.
To illustrate the difference between the two, assume that X and Y are joint owners of real estate.
If X and Y are tenants in common, the ownership interests of X and Y do not have to be equal. For example, X could own 1% of the real estate and Y could own 99%. Alternatively, X could own 25% and Y could own 75%. Or they could each own 50%. As well, each of X and Y will be able to pass their respective interests on to their heirs. Specifically, each of X and Y can leave their respective interests to their children.
If X and Y are joint tenants, the situation is quite different. By definition, each joint tenant owns an equal proportion of the property. For example, X cannot own 1% while Y owns 99%. Each of X and Y have to own 50%. Furthermore, each of X and Y have a right of survivorship. This means that the survivor of X and Y will end up owning the entire property. If X dies first, X cannot leave his interest in the property to his children. His interest passes automatically to Y. Whichever joint tenant outlives the other is the one who ends up with the property and the ability to pass the property to heirs.
Joint Tenancy Problems
A surviving joint tenant automatically takes the interest held by a deceased joint tenant. This rule operates without probate. As a result, many British Columbians have chosen to hold assets in joint tenancy as a way of avoiding probate. However, there are a number of problems with this approach.
First of all, joint tenancy merely defers probate. It does not avoid probate. For example, assume that a husband and wife own property as joint tenants. If the husband dies first, there is no probate of the property because it passes automatically to the wife. However, there will be probate of the asset on the death of the wife (she is then the sole owner of the property).
The wife could once again defer probate by retitling the property after the husband's death. For example, the wife could become a joint tenant with her adult child. However, that retitling of the property will result in a disposition of 50% of the property. This disposition could give rise to immediate capital gains tax.
If the property is the principal residence of the wife, the capital gain will be tax-exempt. However, a deferred tax cost will arise. For income tax purposes, a person can have only one principal residence. If the child already has a residence, the child will not be able to claim the principal residence exemption on both the child's residence and the child's 50% interest in his mother's residence. If the residence is sold after the mother's death, 50% of any gain that accrued after the child became a joint tenant will be subject to capital gains tax. Depending on the rate of increase in property values, the capital gains tax that is triggered could be much higher than the probate tax that is avoided. This capital gains tax would not have been payable if the wife had remained the sole owner of the residence until her death.
Some British Columbians have been attempting to avoid probate by having registered title held by a parent and child as joint tenants and having a side agreement under which the child holds his interest in the property on behalf of the parent (or holds only a very small percentage interest in the property). This structure simply does not avoid probate. No joint tenancy has been created, because joint tenancy requires that each joint tenant have an equal interest in the property.
Joint tenancy results in loss of control. As noted above, the surviving joint tenant gets full ownership of the property. Full ownership includes full control. For example, assume that Mr. and Mrs. Z own property as joint tenants. If Mr. Z dies first, Mrs. Z will become the sole owner of the property. Assume that Mrs. Z remarries (people who have enjoyed happy marriages often marry again). Mrs. Z may well make her new husband a joint tenant of all her property. Under the spousal transfer provisions of the Income Tax Act, Mrs. Z can do this without triggering income tax; consequently, she thinks that there are no significant consequences to the change. If Mrs. Z predeceases her new husband, however, all that property will become the property of the new husband. The new husband's will may leave all his assets to his children. The result is that the children of Mr. and Mrs. Z get disinherited through inadvertence.
Loss of control is particularly troubling when assets are held in joint tenancy with a child. Parents and children are at different stages of life. While the parent may be looking forward to retirement with a healthy nest egg that the parent has built up over time, the child is often going through a process of establishing a business or acquiring assets. This means that the child is taking on debt and incurring liabilities. If the child is a joint owner of property, the child's percentage interest in that property is an asset of the child and is subject to claims by creditors of the child. For example, assume that the child is a joint owner of the parent's home and the child's new business goes under. The child's creditors will likely make a claim against all the assets of the child - including the child's interest in the parent's home.
Children can also run into matrimonial difficulties. If the child is a joint owner of the parent's property and separates or divorces, the parents may see a significant percentage of "their" property going to the former spouse of their child.
Finally, one cannot control who the surviving joint tenant will be. Assume that a parent owns assets jointly with a child and the parent and child are both killed in the same accident. If it is impossible to tell which person died first, the younger child is deemed to have survived the older parent. In that case, the property would pass under the will of the child. If the child is one of several children, this may not be what the parent intended at all.
Summary
On the surface, holding assets in joint tenancy appears to be an easy and convenient way of avoiding probate. As well, it is psychologically pleasing because of the implied trust and sense of togetherness between the joint tenants. As discussed above, however, joint tenancy has significant drawbacks. It results in a loss of control over the asset, may trigger undesired tax consequences and may result in a person being unable to pass property to intended heirs.
Perhaps the biggest problem with joint tenancy is that it does not provide planning opportunities. Other ownership structures not only avoid probate but can also serve to manage and reduce income tax liabilities.
-- Blair P. Dwyer
The above article provides general commentary of an educational nature. It does not constitute advice for any specific person or any specific set of circumstances. Because circumstances vary, readers should consult professional advisers in order to obtain advice that is applicable to their specific circumstances.