In the January issue of the McMillan Metro Alert, we advised our clients that the State of Maryland had carved out a limited exemption from the 10% inheritance tax for the devise of an interest in a principal residence jointly owned by domestic partners to the surviving partner along with the requirements for qualifying for the exemption. Because of this change in the law, domestic partners may want to consider revising the way that they hold title to their principal residence. In some cases, the partners may need to change the manner in which they hold title from tenants in common to joint tenants with right of survivorship. In other cases, where one partner holds title to the principal residence in his or her name alone, there may be a need to add the other partner to the title. Each such decision has significant legal consequences, however, and it is important that the partners understand these consequences in order to make an informed decision.
If the partners own their property together, but do not know how they hold title, they need to look at their deed. The deed is usually in the file with all of their other settlement documents. The deed will indicate the words “tenants in common” or “joint tenants with right of survivorship.” If joint tenants with survivorship is indicated, the partners own title in the manner required by the statute and they only need to execute the necessary affidavit and maintain it with their other estate planning documents in order to be fully prepared to qualify for the new inheritance tax exemption. If the deed indicates “tenants in common,” the partners must change the manner in which they hold title in order to qualify for the exemption. If the partners cannot find a copy of their deed, there are ways to locate a copy online using the various county and state websites now available.
Changing tenancy from tenants in common to joint tenants with right of survivorship is very straightforward. The partners must properly execute, deliver and record a deed from themselves, as tenants in common, to themselves as joint tenants with right of survivorship. The deed can be recorded with minimal cost and the transfer should not cause a default under any mortgage on the property, given that the same parties own the property before and after recordation. The change in tenancy should also not impair coverage under the couple’s title insurance policy, but it would best to confirm this with the title company prior to the transfer. Once this change has been accomplished, title to the residence will pass directly to the surviving partner when the first joint tenant partner dies.
Though easy to accomplish, such a change in tenancy is not to be undertaken lightly. The consequence of such a change is great. A tenant in common may, at any time prior to death, unilaterally change who will receive his or her half interest in the property when he or she dies. A joint tenant cannot make such a change without the cooperation of the other joint tenant. This is certainly fine if the partners continue to get along. If they do not, however, and they have no binding written agreement between them that governs what occurs in such an event, they will be at an impasse. It is an important decision, and one that should be carefully considered.
In many instances, however, the partners do not own their principal residence jointly. There can be many reasons for this. Some are by design since, from an estate planning perspective, joint ownership of a principal residence is not necessarily in the best interests of all domestic partners. However, in those cases where the partners have moved into a residence owned by one of the partners, and the owner partner has always intended to add the other partner to title but just has not done it, this new law is a reason to get it done. Because the domestic partners are not married, however, there are a number of tax and other considerations that should be discussed with their tax advisor.
The actual process of adding a partner to title in Maryland is, again, straightforward. The owner partner executes, delivers and causes to be recorded a deed conveying the property from the owner partner to both partners as joint tenants with the right of survivorship. The deed could also convey the property to both partners as tenants in common, but the partners would not qualify for the inheritance tax exemption upon the death of the first partner to die. The state and counties have adopted an exemption from recordation and transfer taxes on the recordation of a deed between domestic partners provided that the partners execute and present to the county an affidavit affirming that they are domestic partners. This exemption, however, presumes that one partner is gifting the interest to the other. A conveyance for a stated consideration (e.g. money), or in consideration of the new partner’s assumption of responsibility for a portion of the mortgage on the property would not be exempt, and recordation and transfer taxes could be assessed.
The decision of how best to add a domestic partner to title must be carefully considered in light of the partners’ circumstances. The following are some of the many factors to be considered:
Gift Tax Considerations
Pursuant to the annual donee gift tax exclusion, any individual can gift to any other individual up to $13,000 each year (as of 2009) without incurring gift tax consequences. The value of one half of a personal residence, even a personal residence encumbered by a mortgage, is usually much greater than this (though, if the property is subject to a mortgage, the actual amount gifted would be the value of the one half interest reduced by one half of the mortgage). Thus, a domestic partner who wishes to gift a half interest in the residence must file a gift tax return for that portion of the gift in excess of the exclusion amount and, under some circumstances, pay a gift tax. Each individual has available to him or her (as of 2009) a lifetime gift tax exclusion of $1,000,000, meaning that the gifting individual must report the gift, but need not pay the gift tax unless and until the aggregate amount of the gifts exceeds $1,000,000. These gifts up to the $1,000,000 exclusion, however, do count against the gifting individual’s lifetime federal estate tax exclusion. Although there is an unlimited federal estate tax exclusion in 2010, that will expire after this year. As part of the sunset provision, the federal exemption will automatically be reinstated at $1,000,000 for 2011 unless Congress institutes a different amount.
The gifting of an interest also usually causes the basis of the receiving partner to be the same as the basis of the gifting partner, which impacts the gain in value that must be recognized upon a later transfer of the interest. If, however, the property remains the principal residence of the partners throughout their ownership, this may be less of a concern than would otherwise be the case with respect to an investment property.
In making the decision to add a partner to title, partners should speak with their accountant and attorney to evaluate all of the factors that impact the financial aspects of the decision to gift an interest.
Income Tax Considerations
Another possible way to add a partner to title is for the owner partner to sell the interest in the property to the non owner partner. Such a sale must be for the actual value of the interest. This value is best determined by appraisal. A sale for less than the actual value would again constitute a gift. In the case of a sale of the interest, the selling partner would generally “take back” a promissory note for the purchase price of the interest. The promissory note would need to bear interest at a nominal rate to avoid the imputation of interest to the owner partner. However, the note, which can be secured by a junior mortgage against the property (subject to the approval of the current mortgagee), could be forgiven over time in amounts approximating the annual gift tax exclusion and/or actual payment on the note could be deferred until the property was sold. The owner partner would also need to report the sale of the interest to the IRS. Because of the personal residence exclusion, however, this should not constitute a taxable event. Overall, in carrying out such a transfer, great care should be taken to accurately value the interest being transferred, to work with the first lien mortgage company to ensure that the transfer does not trigger a default under its mortgage and to ensure continued coverage with the title company following the transfer.
Non Tax Considerations
If the property to which a partner is being added is subject to a mortgage, partners should also be aware that a transfer of an interest, without mortgagee consent, almost always constitutes a default under the mortgage. The lender may, or may not, consent to the transfer or may condition it upon a complete refinance of the loan. It may be the case that the domestic partner receiving the interest is going to be making payments toward the mortgage and will need to take the tax deductions that come from making those payments. This too is a consideration when adding a partner to title, particularly in the current economy.
In addition to these more business-oriented considerations, there are considerations relating to the relationship of the parties and the need for the parties to clearly communicate their wants and needs regarding this very personal issue. It is important that these issues be discussed, resolved and fully addressed in a way that respects the needs of both partners while not avoiding those challenging issues that only become more difficult if the partners stop communicating with one another. Time spent exploring and resolving these concerns initially can make things much easier later. This exploration and resolution should also be reduced to writing to ensure that the partners have an enforceable record of their agreement. Our firm can assist in these conversations and in drafting these important agreements.
While proper planning is necessary to structure the transfer in the best way possible for both partners, the overall savings can be significant and it is time and effort well spent.