Couples that choose to live together without getting married should consider entering into legal relationships through bilateral contracts that define the rights, duties, obligations, responsibilities and other parameters of their relationship. The benefits of a Cohabitation Agreement are:
By having a Cohabitation Agreement, you can avoid the problems and risks that could arise from co-mingling of assets. The risks of co-mingling assets are that the relationships may lack the legal safeguards of marriage and there may be unintended gift tax consequences to the pooling of money. The cleanest approach is to keep finances separate, but that is not always convenient. Sometimes it does not promote relationship building for the couple. Couples should be mindful of the dissolution ramifications when considering entering into a Cohabitation Agreement.
The best method is to open a joint checking account for shared bills, while keeping separate checking accounts for personal expenses.
There are four central issues which should be addressed in a Cohabitation Agreement
The Cohabitation Agreement should be used and relied upon by the couple to guide the process in the event that they break up. If they do break up, a separation agreement or dissolution agreement is best. Mediation by a third-party can avoid the costs of court, as well as the delay. Keeping the documents updated is very important. A finalized agreement should be in place at all times.
Tax Consequences of Transfer of Assets Between Cohabitating Couples
Property ownership
Before adding an unmarried partner’s name to the title of the property, consider the following:
Any assets transferred while living without a fair exchange of value may be considered a "gift" subject to gift tax. You can factor in the annual gift tax exclusion, provided the transfer is a present interest gift that is something the beneficiary receives immediately. Simply by adding a partner's name to a deed, if there is not an exchange of fair value, may constitute a gift subject to tax on the amount the value of the gift exceeds the annual gift tax exclusion.
For example, if a house is worth $200,000 and one partner adds the other partners name to the deed as an equal owner, without any exchange of value, the Internal Revenue Service considers this a $100,000 gift. The owner is required to report a gift tax amount of $86,000 ($100,000 less the $14,000 annual gift tax exclusion as of 2017) and either pay the tax or utilize some of his lifetime applicable federal exclusion amount.
(Note to self: It is a better idea to leverage the gift through an annual gift tax exclusion by way of a mortgage forgiveness plan)
- Addresses the sharing of income, expenses, and property.
- Provides protection they may not have otherwise.
- Sets clear ground rules upfront.
By having a Cohabitation Agreement, you can avoid the problems and risks that could arise from co-mingling of assets. The risks of co-mingling assets are that the relationships may lack the legal safeguards of marriage and there may be unintended gift tax consequences to the pooling of money. The cleanest approach is to keep finances separate, but that is not always convenient. Sometimes it does not promote relationship building for the couple. Couples should be mindful of the dissolution ramifications when considering entering into a Cohabitation Agreement.
The best method is to open a joint checking account for shared bills, while keeping separate checking accounts for personal expenses.
- Joint expenses generally will include housing related costs such as mortgage or rent, utilities, household insurance, property taxes and food.
- Personal expenses typically include clothing, past expenses, personal insurance, personal debt, and individual hobbies or interests.
There are four central issues which should be addressed in a Cohabitation Agreement
- Full disclosure of all assets and liabilities.
- The sharing of income, expenses and property.
- Termination of the relationship or death of a member of the couple.
- Methods to resolve the dispute resolution.
The Cohabitation Agreement should be used and relied upon by the couple to guide the process in the event that they break up. If they do break up, a separation agreement or dissolution agreement is best. Mediation by a third-party can avoid the costs of court, as well as the delay. Keeping the documents updated is very important. A finalized agreement should be in place at all times.
Tax Consequences of Transfer of Assets Between Cohabitating Couples
- In the absence of a legal duty of support, a court order or palimony judgment, payments between cohabitating adults may be considered voluntary and subject to gift tax consequences.
- The traditional shifting of taxation on to the party receiving support will not apply.
- The marital exemption of I.R.C. Section 1041 to an asset transfer will also not apply.
- If you can characterize the payment as being a transfer for prior domestic "nonsexual" services, it may be taxable to the payee.
Property ownership
Before adding an unmarried partner’s name to the title of the property, consider the following:
- What might happen to the property in the event of a dissolution of the relationship?
- Think about the tax consequences related to the transfer because it is basically a gift between partners.
Any assets transferred while living without a fair exchange of value may be considered a "gift" subject to gift tax. You can factor in the annual gift tax exclusion, provided the transfer is a present interest gift that is something the beneficiary receives immediately. Simply by adding a partner's name to a deed, if there is not an exchange of fair value, may constitute a gift subject to tax on the amount the value of the gift exceeds the annual gift tax exclusion.
For example, if a house is worth $200,000 and one partner adds the other partners name to the deed as an equal owner, without any exchange of value, the Internal Revenue Service considers this a $100,000 gift. The owner is required to report a gift tax amount of $86,000 ($100,000 less the $14,000 annual gift tax exclusion as of 2017) and either pay the tax or utilize some of his lifetime applicable federal exclusion amount.
(Note to self: It is a better idea to leverage the gift through an annual gift tax exclusion by way of a mortgage forgiveness plan)