Saturday, February 17, 2007

Another Joint Tenancy Gone Bad

I entitled one of my earliest posts on this blog “Six Potential Pitfalls Parents Should Consider Before Transferring Real Estate Into a Joint Tenancy with Their Children.” (I have thought of a seventh, but that is not what I am writing about today.) It seems like I am always suggesting to people that they not do it, often after they have received the exact opposite advice from someone else. Sometimes, when I get a phone call from a parent asking me to do the paper work to transfer the title to his or her home to a son or daughter, I send them my article. Usually, after I send my article to the parent, I don’t get instructions to transfer the title. In this way, my article has cost me business. But, I don’t mind.

In a case decided in December, called Schoennagel v. Schoennagel and Gateway Automotive, 2006 BCSC 1830, Daphne Schoennagel did transfer her house into a joint tenancy with her daughter. After her husband died, Daphne Schoennagel moved from 100 Mile House, B.C. to New Westminster, B.C. She bought a house in October 1996, in New Westminster, which she registered in her sole name.

In 1997, her accountant advised her that if she transferred her house into a joint tenancy with her daughter, she could avoid probate fees.

In 2000, Daphne Schoennagel’s daughter prepared a letter for her to sign instructing a lawyer to prepare the documents to transfer the house into a joint tenancy. The lawyer spoke with Daphne Schoennagel on the phone, and then sent her the transfer documents. She signed the transfer before a notary public. The lawyer then had the title transferred into a joint tenancy with her daughter.

Daphne Schoennagel testified that when she transferred the title, she considered that the house was still hers. She agreed to transfer the house into a joint tenancy because at the time, she wanted her daughter to get it on her death. Her daughter did not want to have to pay probate fees on the value of the house on Daphne Schoennagel’s death. (When title is held in a joint tenancy, on the death of one joint tenant, the other acquires title by right of survivorship. In some cases it may not be necessary to probate the will at all, or if it is probated the survivor can avoid paying probate fees in respect of the house.)

Unfortunately, Daphne Schoennagel and her daughter later had a falling out. Daphne Schoennagel sued her daughter for the return of the daughter’s interest in the title to the house. She argued that the transfer should be set aside on the basis of duress, undue influence or as an unconscionable transaction.

Mr. Justice Truscott of the Supreme Court of British Columbia dismissed Daphne Schoennagel’s claim. He found that she intended a gift of an interest in the house when she transferred it into a joint tenancy with her daughter.

Should this have been avoided? I think so. Sometimes people are too quick to blame their advisors when things go wrong. But, in this case, I can’t help but wonder how well Daphne Schoennagel’s advisors served her.

According to the reasons for judgment, Daphne Schoennagel's accountant advised her about avoiding probate fees. How much probate fees would Daphne Schoennagel’s daughter avoid? The answer is about 1.4% of the value of the house on death. It could possibly be more, if there were other assets, and if probate could be avoided altogether. Given the real estate market in British Columbia in recent years, the value is probably substantially higher than the $241,000 Daphne Schoennagel paid for it, but even if it were a worth a million dollars, the probate fees would be $14,000 on that million (assuming there are at least $50,000 of other assets).

What are the other tax implications of the joint tenancy? I don’t have sufficient facts to know for sure, but I am guessing that this house qualifies as Daphne Schoennagel’s principal residence. If she can claim the house as her principal residence until she sells it or dies, any increase in the value of her interest in the house would be sheltered under her principal residence exemption.

On the other hand, her daughter does not live in the house, and probably can’t shelter any of her interest in the house under the principal residence exemption. When she sells her one-half interest in the house, she will have to pay tax on the increase in value of her interest. If it is subject to capital gains tax, one half of the increase of her one-half interest in the house will be taxed as income for the daughter. The amount of tax will depend on the daughter’s marginal income tax rate. The top rate in British Columbia is, last time I checked, about 44%. The income taxes the daughter will eventually have to pay will likely significantly exceed any potential savings of probate fees.

This potential tax problem would likely have arisen even if mother and daughter had not had a falling out. The daughter might have been able to argue that she was holding her interest in the title in trust for her mother all along, and that the full amount of any appreciation in the value of the house should be treated as her mother’s gain. But, I assume that if there were any documents saying that the daughter was holding an interest in trust for Daphne Schoennagel, they would have been brought up at trial, and the outcome would be different.

Did the lawyer or notary public advise Daphne Schoennagel that she would lose control of the house, if she transferred the house into a joint tenancy with her daughter? Did either of them advise her that it could be difficult to get the title back if she changed her mind? Did they advise her of the income tax issues? I don’t know the answers from reading this case. It’s quite possible that they did advise her of the potential pitfalls of transferring the house into a joint tenancy, and that she decided to do so anyway. But too often, people are making decisions to avoid a 1.4% tax without considering the significant implications of what they are doing.

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