Creating Joint Ownership: Avoiding the Tax Traps and Other Pitfalls

(Part 2 of 2)

Last month’s column showed how adding a child or other nonspouse family member to the title of property as a joint tenant can create unintended consequences of deemed gifting for gift tax purposes. In that illustration, Jack added his daughter, Liz, as joint owner of rental property, immediately triggering a transaction subject to gift tax on Liz’s interest in the property.

And if Jack had counted on the transaction to reduce the value of his estate, he’d be doubly disappointed. This is because the entire value of jointly owned property must be included in Jack’s gross estate—not the one-half interest that he owns. The only way to get around this would be to prove that Liz contributed her own funds toward the cost basis of the property (see Treas. Reg. § 20.2040-1(a)(2) and IRC § 2040).

Jack’s estate and his family could face a double whammy if Jack lives in a state that sets its own threshold for taxing estates. In Maryland, for example, his estate would be subject to as much as a 16% tax if its overall value exceeds $1 million. In jurisdictions like that, Jack’s estate would have to pay an estate tax to the state of residence.

When valuing property and an interest in a business for gift and estate tax reporting purposes, the tax adviser needs to be wary of the tightened rules under the Pension Protection Act of 2006 governing valuations. The IRS has been gearing up to target presumptuous property valuations with penalties not only against tax preparers but against independent appraisers and valuation experts as well.

Let’s take a look at what Jack might have to face in his quick-fix planning effort and the creation of a joint tenancy with his daughter. At first blush, valuing an investment property for gift tax purposes does not appear to be a big deal. Regardless of which state he lives in, it is clear that Jack needs a timely valuation of the gifted property—a task easily handled by any qualified appraiser. However, when any property is transferred by gift, the valuation expert is required to look at other factors that might have a nexus with fair market value. These factors are described in Revenue Ruling 59-60.

For example, the real estate that Jack owned might have had some business connection affecting its value. The existence of a special lease contingency could require more extensive detail for a reliable appraisal report. Under the new penalty-laden rules, more comprehensive details are often required in all appraisals to confirm that the valuation truly meets the “willing buyer” and “willing seller” rules—particularly when family members are involved.

Finally, one other special factor comes to mind with Jack’s effort to obtain a (penalty-free) valuation of the gift transfer that was made when he created a joint tenancy with his daughter. It involves the question of the marketability of a fractional interest in property in general (see Technical Advice Memo 9718004). It is clear that there should be a discount in the valuation of Jack’s one-half joint interest in the property because of factors such as a lack of a market for fractional interests in property in a particular area and the costs of a forced partition and sale. Unfortunately, there is not a clear authority for Jack or anyone else who seeks statutory guidance for calculating the exact amount of a discount for a one-half interest in property held as joint tenants with rights of survivorship. On the other hand, a wide variety of court cases and tax court memoranda provide guidance for valuing fractional interests of property when they are held as tenants-in-common.

In the end, logic seems to say that there should be little difference with the “discounts for lack of control” if the co-owners are joint tenants, as opposed to tenants-in-common. Hence, it may be argued that Jack’s property transfer to his daughter should be allowed an ample discount to minimize unnecessary gift tax exposure.

Planner’s alert summary.Under the new rules, the message is loud and clear to any practitioner whose client plans to create joint ownership with any property other than a bank or brokerage account. If the property is investment property, a business interest or even a personal residence, you need to be wary of those “quickie” one-page valuation reports that were commonly accepted under the old rules.

By Thomas J. Stemmy, CPA, CVA, EA, MMS, a partner with Stemmy, Tidler & Morris PA in Greenbelt, Md. His e-mail address is


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