Ways of Owning Property Interests – And How It Affects Your Heirs

 Buying a property is an excellent investment, no matter if it is for your primary residence or as a source of income. However, suppose you are in a relationship and have a spouse or investing with another person. In that case, there are several ways the property ownership interest can be recorded in the Deed depending on the state laws.

How do you decide the best type of ownership interest from a tax and estate planning perspective? The first step is deciding if you will own the property as a sole owner, with a spouse, other family member, friends, or other business partners? 

In essence, based on how the property ownership is structured, it has both tax consequences and how it transfers to your estate to the heirs.

Sole ownership

Let’s say Joe Smith is single and wants to buy a primary residence under his name only. The property will be owned 100% by Joe Smith. If Joe were to sell the home, as long as Joe meets the IRS requirement on capital gain tax exemption, he would not incur any capital gain tax. If Joe were to pass away, his home could transfer either via probate through a will or intestate where there is no will, and the state law of Joe’s residency applies in transferring the assets. According to state law, dying without a will is more expensive since the state would be in charge of distributing assets. His estate will include the fair market value of the home in his estate.

Tenants in Entirety

Now let’s say Joe is married to Jane and they both want to buy a home. One of the easiest Joe and Jane can transfer the ownership is by owning the property as Tenants in Entirety. This avoids any speculation about the spouse's intent. When one spouse is deceased, the ownership is automatically transferred to the surviving spouse and automatically qualifies for the unlimited marital deduction. The other benefit is that one spouse cannot transfer their ownership without the other spouse's consent. Each spouse owns 50% of the property; therefore, 50% of the property's fair market value is included in the deceased estate. The surviving spouse gets a stepped-up basis only from the 50% ownership of the deceased spouse. Tenants in Entirety is only available to married couples.

Community Property

As a married couple, another ownership type that is affected when they purchase ownership interest is if Joe and Jane lived in one of the community property states. What are community property states? They are Louisiana, Texas, New Mexico, Arizona, California, Washington, Nevada, and Wisconsin. This option, available only to spouses, regardless of how much each spouse contributes to acquiring ownership, ownership is automatically 50% for each. When a spouse passes away, it is included in the spouse's estate, but the main difference is that each 50% ownership gets a stepped-up basis. What does that mean? Let's say John and Jane owned a home titled in a community property state. The property cost was $200,000 with 50% ownership. Ten years later, the property is worth $400,000 when John passes away. Under community property state law, John’s estate will get a step-up basis on his share of 50%, which is $200,000, which he can pass to any heir. Jane, in this case, ALSO gets a step-up basis of $200,000, so when she sells the home, her new cost is $200,000 for tax reasons.

One major point to note is that any property acquired before marriage or through gift or inheritance is not considered community property. It is only property if it is acquired after marriage.

Tenants in Common

Now let’s say Joe wants to buy a property with another person. That can be his spouse if he is married, or friends, or other business partners. The best option of ownership structure in Tenants In Common (TIC) is that the interest in the property is based on each individual's contribution under TIC ownership. When one owner of the property passes away, their interest is passed to their estate at the fair market value. In this situation, the descendant's interest passes through probate and qualifies for the unlimited marital deduction if it passes to a surviving spouse. This is a wonderful option for owning real estate between relatives, friends, or other business partners. It allows each owner to transfer their ownership to someone else if they chose to sell their interest to generate cash without affecting other owners. TIC is also a great exit for small business owners in partnership with continuing 1031 individually if they choose to sell their ownership percentage.  

Joint Tenancy with Right of Survivorship

Like TIC discussed above, two or more individuals own the property in Joint Tenancy with Right of Survivorship; however, the ownership is equally divided among all individuals. Let’s say Joe wants to buy a property with John and Jane. Under this property ownership, all three, Joe, John, and Jane will have equal ownership. If Joe passes away, his 1/3 ownership would be divided between John and Jane instead of passing to Joe’s estate; hence, the “right of survivorship”. This means that the interest does not have to go through probate either, saving tremendous court costs. Like TIC, Joe can sell his interest, but the difference is that the new owner's interest will be titled "Fee Simple."

Owning property is just one part of a sound financial plan. At Luminous, we will be happy to sit down with you and make sure you understand how your property is titled and how it fits in with your overall financial plan.