Real property is the cornerstone of many Americans’ wealth, but the manner in which one acquires real property can have a dramatic affect on the owner’s ability to protect the property against the claims of creditors and to preserve the property for future generations. As a result, before entering into any real estate transaction, it is important to understand the various forms of property ownership, and the pros and cons of each.
Sole ownership is a form of property ownership whereby an individual owns the real property outright in his or her own name. While this form of ownership has the advantage of simplicity, it does not offer any of the built-in asset protection or estate planning features of other forms of property ownership described below.
Real property that is solely owned may be foreclosed upon by the owner’s creditors in the same way as other solely owned assets (such as bank accounts). Likewise, upon the death of the owner, the real property becomes part of the owner’s estate, where it could also become subject to the claims of creditors of the estate before it ever reaches the owner’s heirs.
Joint ownership is property ownership among two or more individuals/entities and may take the form of tenancy in common, joint tenancy with right of survivorship or tenancy by the entirety.
Tenancy in Common
In a tenancy in common, two or more individuals/entities own distinct interests in the real property. These interests need not be equal; for instance, one owner could own 50% of the property, one owner could own 30% of the property and one owner could own 20% of the property. However, even if one’s share is less than that of another, each owner has the equal right to possess or use the property.
Unlike tenancy by the entirety, tenancy in common allows for each owner to sell his or her interest in the real property without the consent of any other owner. By that same token, creditors of an owner may take title to that owner’s interest in the real property without affecting the interests of any other owner. Upon the death of one owner, his or her interest passes to his or her heirs, who will then become tenants in common with the surviving owners. As with sole ownership, tenancy in common does not offer any built-in asset protection or estate planning features.
Joint Tenancy With Right of Survivorship
In a joint tenancy with right of survivorship (or “JTWROS”), two or more individuals/entities own distinct interests in the real property, but upon the death of an owner his or her interest is automatically distributed among the surviving owners. In this way, JTWROS offers built-in estate planning because it determines ownership upon the death of one owner. Property succession in this manner will trump the terms of a will – even if an owner specifically devises his interest in JTWROS property to a non-owner, such devise will be totally ineffective. Furthermore, because the property passes outside of the deceased owner’s estate, it cannot be reached by the creditors of the deceased owner’s estate.
There are four requirements – or “unities” – that must be present in order to create a joint tenancy with right of survivorship:
(1) All owners must take possession of the property at the same time.
(2) All owners must take title by the same instrument, such as a deed or a will.
(3) All owners must have an equal interest in the property. This is the case even if one of them paid for the entire property.
(4) All owners must have the right to possess and enjoy the entire property even though he or she does not have a 100% ownership interest.
Unlike tenancy in common, creditors of one who owns real property titled as JTWROS cannot easily take title to the debtor’s share of the property; rather, a creditor could place a lien on the debtor’s share of the property, but the lien does not entitle the creditor to seize any portion of the property. The creditor would have to sue all of the owners for partition by sale (discussed below) before he/she could recoup the amounts owed from the sale proceeds. However, if the creditor places a lien on the property and does not sue for partition, and the debtor dies before the other owners, then the creditor’s claim against the property is lost.
Tenancy By the Entirety
Tenancy by the entirety is a form of joint ownership that is available only to spouses and results in each spouse owning 100% of the property. As a result, each spouse has the equal right to possession and use of the entire property, and neither spouse can transfer his or her interest in the property to a third party without the consent of the other.
As with JTWROS, upon the death of one spouse, the surviving spouse inherits the entire property automatically – the property passes to the surviving spouse outside of the deceased spouse’s estate and cannot by reached by the creditors of the deceased spouse’s estate. Furthermore, while creditors of one spouse can place a lien on the debtor spouse’s interest in the property, they cannot sue for partition and force the sale of the property, and if the debtor spouse dies before the non-debtor spouse, then the creditor’s lien becomes null and void. These features make tenancy by the entirety an attractive form of property ownership for spouses.
Breaking Joint Ownership
Tenancy in common and joint tenancy with right of survivorship may only be broken by partition. Partition is a legal action whereby a party petitions the court to divide the property into different lots or sections. There are two general types of partitions. The first is a partition in kind, which is the physical division of land. The court determines how to divide the property based on the ownership interest of each tenant in common. This type of partition is most appropriate where the real property consists of several tracts or acres.
The second type of partition is a partition by sale, whereby the court orders the sale of the property, even if all owners do not want to sell their interest in the property, and the directs the distribution of the profits to each owner in relation to their ownership interests.
In contrast, tenancy by the entirety may only be terminated (1) upon the death of one spouse, (2) upon the divorce of the spouses, (3) by the joint transfer of the property by the spouses to one of the spouses, to an entity created by the spouses (such as a trust or LLC) or to a third party or (4) by mutual agreement of the spouses. Neither spouse may not sue for partition of real property owned as tenancy by the entirety.
Real property ownership via a limited liability company offers its own unique benefits. A limited liability company is an entity that is similar in structure to a partnership, but with the creditor protection of a corporation. An individual, or several individuals or other entities, can form an LLC and, in exchange for a capital contribution, each individual or entity receives a membership interest. If the LLC then purchases real estate, none of the members would have a direct ownership interest, but they could share the use and possession of the property (depending on the terms of the LLC operating agreement) and in any net income generated by the property.
Because the members do not directly own the property, creditors cannot place a lien on the property or sue for partition. Furthermore, the LLCs creditors generally cannot not reach the personal assets of the members. For example, if there was a slip-and-fall accident on the property and the LLC was sued for damages, the plaintiff could only recover damages up to the value of the LLCs assets – he/she could not go after the members for any judgment amount above and beyond the assets of the LLC.
The members can agree in advance, in the LLC operating agreement, as to what will happen to the membership interest of a deceased member. If the operating agreement is silent on this point, then the deceased member’s interest will pass to his/her heirs.
Real property ownership via a trust can be designed to protect the real property from the claims of potential creditors while simultaneously accomplishing the grantor’s estate planning goals. Trusts may be used in conjunction with another form of joint ownership; for example, a trust can own an LLC that owns real property, or a trust can be a joint owner of real property with other trusts, individuals or entities.