Internal Revenue Code §2040 sets forth rules dealing with the extent to which property which a decedent co-owned with one or more other parties is includable in decedent's gross estate. The rules differ, depending upon the form of joint ownership and whether the co-owners are husband and wife.
Tenants In Common
Tenancy in common is a form of co-ownership in which two or more parties own specified fractional interests in the entire property. For example, two people could each own a one-half interest or one could own a 5/6 interest and the other a 1/6 interest. Four tenants in common could each own a 1/4 interest or each could own a different fractional share. If any tenant in common dies his fractional interest in the property passes as part of his probate estate to his heirs, the surviving tenant(s) in common having no rights to the deceased's share. In the case of a tenancy in common the gross estate of the deceased co-owner will include the value of his fractional ownership share in the property, applying the general rule of I.R.C. §2033 not I.R.C. §2040.
Joint Tenants With Right of Survivorship (JTWROS)
Joint tenancy with right of survivorship involves two or more co-owners who each own equal shares. In the event of the death of a joint tenant, his share automatically passes to the surviving joint tenant or tenants by operation of law; it does not pass through the decedent's probate estate (Will), as would be the case with a tenancy in common. In the case of a joint tenancy (except where husband and wife are the sole joint tenants, as discussed below), the gross estate of the deceased joint tenant includes a portion of the value of the entire property which corresponds with the portion of the cost of the property which had been provided by the decedent.
Example: If A and B acquire real estate as joint tenants, with A paying $100,000 of the purchase price and B paying $200,000, and A later dies when the property has a market value of $450,000, A's gross estate will include $150,000 (1/3 of the value, based upon his 1/3 contribution ($100,000/$300,000) to the acquisition costs); B would accede to full ownership of the property.
It should be noted that the taxpayer estate has the burden of proof in establishing the proportionate contributions to the cost of the property. Thus, under I.R.C. §2040(a) the entire value of the property is includable in the gross estate, except to the extent that the taxpayer can show a portion attributable to cost contributions by the other joint tenant(s). In the case of joint tenancy property acquired by gift or inheritance, the gross estate of a deceased joint tenant will include the decedent's fractional ownership share.
Special Rules For Co-Ownership of Survivorship Property By Husband and Wife: The Qualified Joint interest Rule
A special rule applies when co-owners are married to each other. Fifty percent (50%) of the value of the jointly held property (or property held as tenants by the entireties) is included in the estate of the first of the spouses to die. Includability is determined without regard to the spouses' respective contributions at the time of the joint tenancy's creation. (Two Circuit Court decisions have held that the cost-contribution ratio rule remains applicable with respect to husband and wife joint tenancies formed prior to 1977. Gallenstein v. U.S., 92-2 USTC 60,114 (6th Cir. 1992) and Patten v. U.S., 116 F.3d 1029 (4th Cir. 1997).)
It should be noted that even though the gross estate of a married decedent will include a portion of the value of property jointly owned with the surviving spouse, to the extent that such portion passes to the surviving spouse upon decedent's death (as would occur automatically in the case of joint tenancy and tenancy by the entirety), the amount includable in the gross estate would be offset by an equivalent marital deduction. While these "in-and-out" mechanics may have no net estate tax consequences, there is an important income tax consequence. To the extent that an interest in property is included in a decedent's gross estate, the then-current market value at which it is included in the gross estate becomes its income tax basis. Thus, a surviving spouse who takes over a decedent's share of jointly owned property may benefit from an increase in the income tax basis of the property, without estate tax consequences.
In addition to the property owned outright at the date of death the gross estate for federal estate tax purposes includes certain other property with which the decedent was connected, as discussed in the following blog posts:
Jointly Owned Property - I.R.C. §2040