Originally published in Canadian Tax Highlights, Volume 15, Number 12, December, 2007. Reprinted with permission.

Canadian spouses frequently hold property as joint tenants to avoid provincial probate fees. However, if one spouse is a US citizen, joint tenancy may give rise to an increased US tax liability that often outweighs the savings on probate. Several US tax issues should be considered before a joint tenancy is created between a US citizen and a Canadian spouse.

Stepped-up basis on death. A US taxpayer who sells property realizes a taxable gain equal to the difference between the US tax basis and the sale price. The basis depends on whether the taxpayer purchased the property or obtained it as an inter vivos gift or on the previous owner's death. Property received on the owner's death generally enjoys a step-up in basis to its FMV on the date of death. If a co-tenant dies and leaves his half of the property to the other tenant, the survivor takes a stepped-up basis in the decedent's half; the new overall basis is the average of the original basis and the FMV at the death. But if the property is held in joint tenancy (or as tenancy by the entirety), the decedent was not a US resident or citizen, and the property is not located in the United States, then the surviving joint tenant may not receive a step-up in basis; the Code allows a step-up only if the value of the decedent's gross estate for US estate tax purposes included his share of the subject property.

A non-US-citizen or domiciliary decedent is not subject to US estate tax on property not located in the United States; thus, the property is not included in the decedent's gross estate and there should be no step-up. It is unclear whether the surviving joint tenant carries over the decedent's basis or must take a zero basis in the decedent's half. However, it is arguable that although the estate tax is imposed only on the gross estate of US citizens and residents, all individuals have a gross estate; under this view, the surviving joint tenant should receive a stepped-up basis.

The lack of a step-up in basis on a joint tenant's death can be a considerable detriment. Assume that a Canadian-citizen and Canadian-resident husband and his US-citizen wife own vacation property in Europe. Each has a $250,000 basis in the property, for a total of $500,000. The husband dies when the property is worth $1 million and his share passes to his wife. If the two spouses hold the property as tenants in common, the wife's new basis is $750,000 ($500,000 date-of-death value for the husband's share plus the wife's original $250,000). A sale of the property at $1 million triggers a reportable gain of $250,000 on the wife's US income tax return. However, if the property is held in joint tenancy and the wife is not allowed a stepped-up basis--but assuming that she can carry over her husband's basis--the wife's new basis is $500,000 (her husband's original $250,000 basis plus her $250,000 basis). A subsequent sale at $1 million yields a reportable gain of $500,000 on the wife's US income tax return.

Tracing requirement on death of joint tenant. If assets are held jointly and one spouse is not a US citizen, the entire value of the jointly owned asset is prima facie included in the US-citizen decedent's gross estate unless the estate can prove that some of the purchase price was contributed by the surviving joint tenant. If the surviving joint tenant is also a US citizen, only one-half of the property is included in the decedent spouse's estate.

Assume that a US-citizen wife predeceases her Canadian husband. Her only substantial asset is a Canadian brokerage account held jointly with her husband, the primary wage earner, who contributed all the account's assets. The value of the entire account is included in the wife's US estate unless the estate can provide adequate records of his contributions to the account, in which case none of it is included.

If the couple knows that their records are inadequate, they should consider severing the joint tenancy while both spouses are alive. When joint property is severed during life, there is less scrutiny, and it is likely that the couple need not provide documentation of their individual contributions. Nevertheless, to avoid making a potentially taxable gift, the value of property allocated to each spouse on the severance should be roughly proportionate to the value of his or her contributions to the account.
Possible gift on creation of joint tenancy. For US gift tax purposes, if an individual purchases real property and conveys title to himself and another as joint owners who can unilaterally sever the joint tenancy, there is an effective gift of one-half of the property to the donee. The governing regulation refers to another regulation, which provides that no gift occurs if the joint tenants are husband and wife. However, the cited regulation has been revoked, and thus it is unclear whether a US taxable gift occurs on the creation of a joint tenancy between a husband and wife. The uncertainty is inconsequential if both spouses are US citizens, because they are entitled to an unlimited gift tax deduction for gifts to spouses: even if a gift occurs, they can claim the deduction and avoid any tax. However, if the donor spouse is a US citizen and the donee spouse is not, the gift tax marital deduction is limited to $125,000 per year ($128,000 in 2008). If a US-citizen wife purchases real property and takes title as joint tenant with her Canadian husband, a gift may occur on the joint tenancy's creation, and the wife may be liable 11for US gift tax (or use her lifetime gift tax credit) if the gift's amount exceeds $125,000.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.