Joint ownership of an account can complicate how capital gains are dispersed and who is responsible for the taxes involved. Adding in the current tax change proposed by President Biden, it is important to understand the impact to tax rules and regulations regarding joint ownership. It’s important to note that this article is focused only on unmarried parties. Married parties fall under an entirely different set of tax ramifications.
President Biden is suggesting a tax increase to 39.6% on long-term capital gains for those earning over $1 million. This is in addition to the 3.8% investment surtax on high-income investors, resulting in a possible 43.4% federal tax of any capital gains, in addition to salary, over the $1 million threshold ($500,000 per spouse).
To illustrate, if you make $900,000 in wages and $200,000 in capital gains, the $100,000 that falls over the threshold will be taxed at the current long-term gain rate, and the other $100,000 will be taxed at your ordinary income rate. This becomes important when addressing the capital gains within joint ownership accounts as you try to minimize tax penalties.
Let’s clarify more:
The investor that provided the capital to purchase the investment is entitled to the increase in the asset's value. If this was a sole individual, they are due 100% of the gains. However, if both owners of the account each provided half, the profits are split. Regardless of what happens behind the scenes, for tax purposes, the income funds are allocated accordingly. To rephrase, you cannot choose who reports the income on their taxes from the account if the known source is one of the holders. Again, it’s important to mention here that this is true for joint ownership of unmarried parties. For married parties in a community property state, titled appropriately (ie jointly or held in community property) the gains are shared equally, regardless of who bought the asset.
Your brokerage or investment company will supply tax documentation to the primary social security number on the account, enumerating the division. Between the two returns, 100% of the gains must be reported, and the IRS might want to match this documentation to an explanation within the next two years. If so, they’ll send you a letter, and you’ll want to provide the documentation as proof. For this reason, you need to keep the record for a minimum of three years.
As for the sale of co-owned property, as long as all parties lived primarily within the residence for two out of the five years before the date of sale, each party is entitled to a $250,000 capital gain deduction.
If you have more questions about joint ownership, please get in touch with us. Your Sand Hill Wealth Manager is ready to work proactively with you and your tax professional to plan for your unique personal circumstances.
Sources: Kiplinger, Morningstar, Nolo, Intuit
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