By Mark A. Segal

In Brief

Being Married Makes a Difference

Holding property in joint tenancy with rights of survivorship has many tax and financial implications. In addition to avoidance of probate, holding the asset in JTROS affects determination of basis and the timing and value for estate tax purposes.

The manner in which real property held in joint tenancy is acquired will determine the value to be included in the estate of a decedent joint tenant and the interest that passes to the surviving joint tenant. Where a donor transfers an asset and subsequent events result in the donor becoming a joint tenant, the tracing rules of IRS section 2040 will apply, except for joint tenancy between husband and wife.

Strategies exist to enhance the attainment of financial objectives through the use of qualified disclaimers in connection with joint tenancy ownership.

Where a joint tenant has outstanding debts, a question may arise as to the rights of creditors to seek collection from the interest held in joint tenancy.

Joint tenancy with rights of survivorship (JTROS) is a popular format in which to hold real property. The most marked characteristic of this type ownership is the right of survivorship. Pursuant to this right, upon the death of one of the joint tenants (JTs), the interest held by the tenant passes to the remaining joint tenants without having to undergo probate. The passing of property in this way often has a dramatic impact upon both the basis of the surviving joint tenant(s) in the property and the estate of the decedent. Determination of this impact is dependent upon the relationship of the joint tenants and the manner in which the asset was acquired.

The Impact of Acquisition

Purchase. The effect of a purchase of an asset in JTROS is dependent upon the relationship of the JTs. As a general rule where assets are acquired in JTROS, inclusion of value in the estate of a decedent JT is determined based upon the percentage of the purchase price contributed by such tenant. The value placed on this interest then passes to the surviving JTs, resulting in an adjustment of their basis. Where more than one surviving JT exists, the basis of each surviving JT is adjusted by a pro rata portion of the value placed on the interest included in the decedent's gross estate.

Example: X and Y, unrelated taxpayers, purchase Sommerdale for $15,000, taking title in JTROS. X provides $10,000 of the purchase price and Y provides $5,000. Y predeceases X at which time the value of the asset is $45,000. As a result, a value of $15,000 ($45,000 x $5,000/$15,000) is placed on the interest held by Y for estate purposes, and X acquires a 100% interest in Sommerdale with a basis of $25,000 ($10,000 purchase price paid by X plus $15,000 for the interest of Y that will pass to X as a result of Y's death).

An exception to the general rule applies where the property is acquired in JTROS by a married couple during the course of the marriage, and the couple is the only owner of the property. In such instance, each spouse is considered to have provided one-half of the consideration regardless of how much each spouse actually provided. Upon the death of the first spouse to die, 50% of the relevant value goes into the decedent spouse's estate and is added to the basis of the surviving spouse.

Example: Assume in the previous example that X and Y are married and acquire the asset during the marriage. Each will be viewed as having provided 50% of the purchase price regardless of the amount either one actually paid. While both spouses are alive, each is considered to have a basis in their interest of $7,500. Regardless of which spouse dies first, the survivor will obtain a basis of $30,000, which is equal to $7,500 plus $22,500 (50% of $45,000).

Different treatment is accorded JTROS between a married couple where the tenancy is acquired during the marriage and before 1977. According to the 6th Circuit decision in Gallenstein, 975F.2d 286 (C.A. 6, 1992), aff'g 68 AFTR2d 91-5721 (D.C. Ky, 1991), determination of estate inclusion and the basis of the surviving spouse in such circumstance shall be determined pursuant to the general rule applicable to a JTROS between unrelated parties. According to this rule, inclusion in the gross estate of the first of the JTs to die is typically determined based upon the percentage of the purchase price provided by such party. In addition, all consideration for the asset is assumed to have been provided by the first of the JTs to die, unless established otherwise. Where the JTROS is held between a married couple, any inclusion related to the JTROS in the estate of the first of the spouses to die is offset by the marital deduction.

Gift. The implications of a gift of property in JTROS is dependent upon whether the donor retains an interest in the asset as one of the joint tenants. Where the donor gifts the entire interest in the asset to others, each donee will receive a basis determined pursuant to the gift rules. The basis of each donee is based upon their pro rata interest in the asset. Thus, if the gift is made of property in JTROS to three individuals and the basis of the donor is $6,000, each of the donees will be considered to have a 1/3 interest in the asset and, as a consequence, a $2,000 basis. Where the property is left to others at death, in JTROS treatment similar to that of a gift of property in JTROS is applicable.

Example: F gives three children land that has a value of $25,000 and a basis of $9,000. For gift tax purposes the donor has given three gifts of $8,333 each. Each of these gifts qualifies for the gift tax exclusion. The children, in turn, each own a 1/3 undivided interest in the property, and have a $3,000 basis in their respective interests. Some years later, the first of the three children dies at which time the land has a value of $60,000. The value of the interest in the property included in the decedent child's gross estate is $20,000 (1/3 of the $60,000 value). This amount is considered to pass to the surviving JTs equally. As a result, the remaining two children each possess a 50% undivided interest in the JTROS with a basis of $13,000 ($3,000 original basis plus 50% ($20,000).

Tracing and Donor Retention

Analysis takes a different turn where a donor transfers an asset and subsequent events related to the asset result in the donor being a JTROS. The major rule of importance in these instances is the tracing rule of IRC section 2040. This rule is applicable to all JTs other than those between husband and wife. According to the tracing rule, the entire value of an asset held in JT is to be included in the gross estate of the first of the JTs to die except where the contribution to acquisition by the survivor can be established.

An example of the rule is where a father acquires an asset and transfers it to JTROS naming himself and child as JTs. Should the father die first, the entire value of the asset would be included in the father's estate due to his being the source of the consideration. In contrast, were the son to die first, there would be no inclusion in the son's estate and no related adjustment to the father's basis.

Another scenario arises where a gift of an asset is made to another, followed by the donee placing the asset in JTROS or using the funds given to acquire property in JTROS, with the donor being one of the JTs. In both cases, the tracing rules would consider the donor to be the sole source of consideration for the asset. As a result, 100% of the value would go into the donor's gross estate should the donor die first, but none would be included in the donee(s) gross estate were the donee to predecease the donor.

There is a different result when the donee earns income on the asset given or sells it for gain with the proceeds being used to acquire property in JTROS. In such event, the original donee is considered to have made a contribution to the acquisition of the asset. In these instances the donee is considered to have provided independent consideration to the extent of the income earned or gain recognized by the donee (above the value of the asset on the date of the gift) that has been reinvested in the JTROS.

Example: Father transfers stock to son. The stock produces dividend income the son uses to purchase land. Title to the land is taken in JTROS with father. Son dies before father. The entire value of the land is included in the son's gross estate. The father, in turn, acquires 100% ownership of the land and a basis equal to the value placed on the asset in the son's gross estate. This is because the income produced on the asset is deemed the son's separate property.

Example: Father transfers land to son. At the time of the transfer, the land has a basis to the father of $10,000 and a fair market value of $12,000. The son holds the land for two years at which time he sells the land for $20,000. The proceeds are then used to acquire other real property for $20,000 that is taken in JTROS with father. The son dies before the father at which time the land has a value of $25,000. In this case, the son is treated as having provided independent consideration to the extent of the appreciation in value since the date of the gift. As a result the son is viewed as having provided 40% of the consideration [($20,000­$12,000)/$20,000] and $10,000 is includible in the son's gross estate ($25,000 x .4), and added to the father's basis.

Disclaimers

Utilization of qualified disclaimers has become a staple of modern estate planning. Issuance of a qualified disclaimer will result in the disclaimant being treated as though never having received an interest in the asset. Through proper planning, a disclaimer can be used to maximize use of the unified credit, increase the marital deduction, or have property pass to an individual in a manner qualifying for beneficial tax treatment. IRC section 2518 provides that a qualified disclaimer must meet the following criteria:

* A written renunciation must be made by the party issuing a disclaimer. The renunciation should be dated, signed, and notarized.

* The writing must be received by the party creating the interest or the legal representative of such party, e.g., executor of an estate, no later than nine months after the transfer creating the interest or nine months after the disclaimant reaches age 21. Mailing by certified mail is one means of establishing evidence of timely receipt.

* The disclaimant must not have accepted the interest or any of its benefits.

* As a result, the interest passes to someone other than the disclaimant without any direction on the disclaimant's part.

The following example illustrates the possible benefits that can be derived from use of a qualified disclaimer.

Example: M dies leaving $5,000,000 of his $5,200,000 gross estate to his wife G, despite their having four children. While M's estate would likely not be subject to tax due to the marital deduction and the unified credit, this disposition increases the amount of G's gross estate susceptible to estate tax upon her death. This is because the amount left to G is likely more than ample to meet her needs, and does not optimize the amount that can be left to others pursuant to the unified credit. Should G issue a qualified disclaimer for the amount of the unified credit and that amount then passes to the children, this additional amount would be removed from both spouses' estates free of estate tax.

A longstanding issue concerning qualified disclaimers of an interest in JTROS involves the start of the disclaimer period. Does it start when the JTROS is initially created or when a JT dies? Clearly if a person has no desire to be a JT when the interest is first created, a disclaimer should be made right away. The problematic part concerns the treatment of the interest held by another JT in which the taxpayer has but a contingent remainder interest. Courts have come to different conclusions on the issue. Recently the IRS has expressed its position with the issuance of proposed regulations.

Pursuant to the regulations, the beginning of the disclaimer period is dependent upon whether the JTROS is amenable to unilateral severance. If the JTROS is subject to such severance, the disclaimer period begins to run upon the death of the JT whose interest is subject to the disclaimer. If unilateral severance is not available, the time period for making a disclaimer of what amounts to a contingent remainder interest begins to run when the JTROS is initially created. The IRS's approach is reflected in PLR 9733008. In that ruling the IRS allowed a qualified disclaimer to be made nine months after the death of a JT where state law (Maine) provided for unilateral severance.

Example: Husband and wife hold all of their assets in JTROS between them. The state in which they reside and whose law will control determination of their gross estate provides that JTROS are amenable to unilateral severance by a JT. Under the proposed regulations, upon the death of the first spouse, the surviving spouse will have nine months within which to disclaim his (her) interest in the JTROS. Were the controlling law to provide that neither JT could unilaterally sever the JTROS, the surviving spouse would have to disclaim within nine months of original acquisition of the title in JTROS. Where a disclaimer is ineffective, and the interest in property goes to another, the interest will be viewed as having gone from the decedent to the surviving JT, with the surviving JT then gifting the interest to the eventual recipient.

For disclaimers made after December 30, 1997, final regulations permit a post-death disclaimer regardless of severability.

Liens

Where a JT has outstanding debts, a question may arise as to the rights of creditors to seek collection from the interest held in the JTROS. In certain instances, the execution of such lien may result in the JTROS being converted to a tenancy in common. The right of survivorship is not applicable to tenancies in common. The susceptibility of property held in JTROS to a lien raises other concerns as evidenced by the recent cases of United States v. Librizzi, 79 AFTR2d Par. 97-568 (7th Cir. 1997) and Marshall v. Marshall, 77 AFTR2d Par. 96-452 (USDC Minn. 1995).

In the case of United States v. Librizzi (1997), the Seventh Circuit ruled that a Federal tax lien that attached to the husband's interest in a JTROS was not limited to the value of the husband's interest at the time of the husband's death. The case concerned real estate held by husband and wife in JTROS. The IRS had assessed $1,500,000 in outstanding taxes against the husband. As a consequence, the IRS filed notices of a tax lien. Subsequently the husband died and the wife as the surviving JT took full title to the property. The government then commenced a foreclosure action. The surviving spouse conceded the tax lien attached to the decedent husband's 50% interest, but contended the amount the government was entitled to for such interest was limited to 50% of the value of the asset at the time of the husband's death. The taxpayer was successful in the district court, but the decision was overturned by the Seventh Circuit. According to the Seventh Circuit, had the government enforced the lien earlier, the only remaining amount the wife would have been entitled to was her 50% interest and that result did not change due to the husband's death.

In Marshall, a district court in Minnesota ruled that the IRS could not enforce a lien so as to sell the interest of a joint tenant where the state law prevented unilateral severance of a JTROS. According to the court, the IRS could acquire no greater rights in the asset than that held by the taxpayer under state law. Thus, if the taxpayer were unable to alienate his interest, the IRS could not do so either. *