Assets owned by an individual provide the landscape for an Estate Plan. This second part will analyze the effects that title to assets has in estate planning, especially when using trusts.
Many well-drafted Estate Plans use trusts. Sometimes, clients simply want to avoid probate, which can be an expensive, time-consuming, and often, public process, and trusts present a great way to do that. Other individuals use trusts because of the benefits that they provide both during life, for example during a period of disability, and after the death of the grantor by providing asset protection, remarriage protection, asset management, and other benefits which might not be otherwise available. While I know that that trusts provide many benefits, some clients might question whether it’s necessary to use a trust for a property that’s held as tenants in common, joint tenants with rights of survivorship, tenants by the entireties, or community property.
If you hold title to an asset as separate property or as a tenant in common, that does not avoid probate. In addition, assets titled in either of those ways offer no asset protection or any other trust benefit noted above. For example, upon your death, your interest in that property would be subject to probate and any proceeds received from the sale of such interest would be used to pay the creditors of your estate. Here it seems clear that transferring tenants in common property or separate property to trust benefits both the owner of the property by avoiding property and the future beneficiaries of that property by offering asset protection and management, among other things.
If we look at joint tenants with rights of survivorship property and contrast it with owning property in a trust, then the benefits of using a trust may not be as readily apparent. For example, a title held as joint tenants with rights of survivorship avoids probate and all joint tenants are entitled to equal use and possession of the entire property, along with any income or profits generated by the property. Unfortunately, it’s easy to destroy survivorship rights. One joint tenant acting unilaterally may sell or transfer their interest in the property thereby severing the rights of survivorship and converting the property to tenants in the common property. Additionally, in most states, a creditor of one joint tenant can attach the interest of that joint tenant terminating the survivorship rights. Finally, although all states except Louisiana recognize this form of ownership, most prohibit a trust from holding title as joint tenants with rights of survivorship because a trust cannot die. Thus, while joint tenants with rights of survivorship avoid probate, it does that only until the property ends up with the last joint tenant. At the death of the last surviving joint tenant, the property would be subject to probate.
In the states that recognize tenants by the entireties, some such as Illinois, Missouri, and Delaware allow residents to transfer tenants by the entireties property to their joint trust and maintain the ownership and benefits of tenants by the entireties. Michigan is in the process of updating its statutes to expressly permit its residents to hold tenants by the entireties property in a trust. In the states that do not authorize the transfer of tenants by the entireties property to a joint trust, planning professionals must give significant thought to the ramifications of breaking up tenants by the entireties property by transferring it to a trust. In most states that recognize tenants by the entireties property, a creditor needs to be a creditor of both spouses in order to attach the property. This unique protection may appeal to married individuals that have one debtor spouse. Issues arise, however, in a second marriage or blended family situation with the surviving spouse taking the entire interest in that property. That could cause undesirable results such as the surviving spouse disinheriting the children of the decedent spouse.
Community property provides various benefits, most importantly a step-up in the basis of the entire community property interest upon the death of one spouse, rather than just the decedent spouse’s portion, as would be the case for property held as tenants by the entirety, joint tenancy, or separate property. Community property allows for flexibility in estate planning and can be transferred to a trust and maintain its character. In addition, in community property states, it’s possible to convert other types of property to community property in the trust. Finally, spouses maintain the power to dictate how and to whom their portion of the community property will pass, even when titled in a trust,
Transferring property to a trust often provides the best protection for the property. It’s imperative to understand the forms of ownership that your state recognizes and the potential benefits associated with each as well as the benefits of trust ownership. Title to the property has a profound impact, even on those assets held in trust.