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Deed document

Deeds have duties, but they fall short as an estate planning tool

by Tom Alberts | Senior Contributor
December 26, 2018

Numerous types of deeds exist with wide-ranging conditions regarding the ownership of real property and survivorship rights. As an estate planning tool, deeds address what happens to property upon an owner's death - but they fail to address contingencies that occur during life and can introduce other challenges. It's important to determine the best planning approach to meet objectives during your lifetime and beyond. A comprehensive estate plan that utilizes a revocable living trust can preserve your control, protect your interests and address issues that arise when using deeds to convey property ownership.

Ownership of real estate is an essential part of the traditional American dream and a foundation of a family's life together. It's also an investment in which a significant part of your financial legacy resides.

Many people acquire real property of all types - residential housing, rental and commercial properties, vacant lots and farmland, to name a few - over a lifetime as part of estates that benefit generations to come. Improper planning and misguided use of deeds to convey property can lead to costly mistakes that potentially leave real property exposed to probate, creditors and lawsuits. Use of the proper deeds to transfer ownership of real property in combination with other estate planning tools - such as a revocable living trust - can help prevent the American dream from becoming an estate planning nightmare. Consider, for example, the implications of adding someone's name to the deed of your home. The home is now exposed to that person's creditors, lawsuits and divorce settlement. That's just one of the big mistakes you can make when relying on deeds alone in estate planning. A deed in itself is not a reliable estate plan - unless you have a crystal ball and can determine the script of life ahead of time.

What is the role of deeds in estate planning?

As a legal instrument filed with the county recorder's office, a deed conveys ownership of an interest in real property from the buyer to the seller and provides documentation of who sold or transferred title of the property (the grantor) to the purchaser or recipient (the grantee). Deeds include information about the date of the transaction, a detailed legal description of the property's location and any covenants, restrictions and obligations for the grantee to follow. More importantly, deeds provide evidence of ownership, or title, and the transfer of ownership. Deeds must be free of title defects - such as liens, legal judgments and other liabilities - for the seller to transfer the title and avoid court challenges over ownership rights. Deeds also provide formal assurances that titles are transferrable and without liens or other defects.

What types of deeds are available?

Tenancy in common

This is the default form of ownership when two or more people own property together. The owners can give away or sell their property interest as they wish. Ownership interests among the tenants can be unequal and the owners do not need to be related. When an owner dies, that person's property interest as a tenant in common is conveyed via last will and testament to beneficiaries and is subject to probate.

Another issue with this type of ownership is the exposure of all the tenants in common to certain risks. Let's say three tenants in common share ownership of an apartment building. If one of the owners is successfully sued, it's conceivable that a creditor could force a fire sale of the entire property to satisfy the judgment. The other two owners would recover their share monetarily in forced liquidation, but the asset of real property would cease to exist. It's also possible that the successful litigant suddenly could become your new business partner as a new tenant in common. The financial and legal difficulties of one tenant can negatively impact the interests of the others.

Incapacity of an owner in a tenancy in common arrangement creates other problems. If a fellow tenant, for example, becomes incapacitated and can't approve a change in the property's ownership status, the matter must be litigated, and there's no guarantee on how a judge may rule. Perhaps a jointly owned asset needs to be mortgaged or sold and the proceeds invested in long-term care in a nursing home for an incapacitated spouse. Without the approval of the incapacitated spouse or a time-consuming and uncertain court order, the property can't be utilized as an asset to provide financial benefits during your lifetime.

Joint tenancy with rights of survivorship

Multiple owners can also hold property as joint tenants with rights of survivorship. In order to create this type of tenancy, the deed must specifically state that joint owners have rights of survivorship. When one joint tenant dies, the property belongs to the remaining joint tenants without using the probate process. The property will be subject to probate when the last owner dies.

Co-business owners standing in front of their store

Many people use this type of ownership as a probate avoidance strategy. This strategy, however, has drawbacks that include exposure to liability and tax implications. For example, after dad dies, mom, hoping to keep the house out of probate when she dies, adds their son's name to the deed with rights of survivorship. In doing so, she has just given away half of her ownership share as a potentially taxable gift to the son. Another problem is mom's exposure to the son's financial liabilities. If he files for bankruptcy or divorce, the loss of his ownership stake could force her to sell and find new living quarters - such as a nursing home. Adding a joint tenant after the value of the property also has tax implications. The new tenant will pay capital gains taxes on the difference between the increase in value from the original purchase price to the present market value when the property is sold. If the property had been inherited, rather than gifted, the basis would step up to the date-of-death value, likely resulting in little if any taxable gain.

Once again, the incapacity of a joint owner, as in a tenancy in common arrangement, limits control over real property and creates a lack of certainty. If either tenant becomes incapacitated, the deed doesn't allow the other tenant to take unilateral action on mortgaging or selling the property. If liquid assets from the property are needed for emergency contingencies, a court petition and hearing could be required. Remember, deeds in estate planning only work to avoid probate at death and fail to address unanticipated life events that are difficult to predict.

Tenancy by the entirety

This type of ownership is only available to married couples. It is created by noting on the deed that the owners are married. The couple owns the property as one undivided entity with rights of survivorship. Upon the death of the first spouse, the property is conveyed outside of probate to the survivor. The property will be part of the survivor's probate estate when he or she passes away. A key benefit of this type of ownership is creditor protection. The individual creditors of the spouses, except for the IRS, cannot place a lien on property held tenancy by the entirety. However, if the debtor spouse survives, the asset no longer enjoys creditor protection. The asset also becomes part of the surviving spouse's probate estate. Because of rights of survivorship, neither spouse cansell or give away their interests in the property.

The issue of incapacity, again, is not addressed by a deed. This can cause problems if, for example, a co-owning spouse becomes incapacitated and can't approve a change in the property's ownership status. Another consequence is who decides how the asset is eventually distributed. The first spouse to die loses control over deciding who receives the property after the death of the second spouse. In many cases, the wishes of the surviving spouseare the same as the deceased spouse. If their wishes are at odds, there's nothing stopping the surviving spouse from disregarding any previous intentions. This is especially important, for example, when children from previous marriages are involved. For instance, the surviving spouse is under no obligation to name stepchildren as beneficiaries, leading to an estate planning failure for the first spouse.

What deeds may be used to avoid probate?

In addition to deeds using the right of survivorship, two other types of deeds exist to allow property to avoid probate at the owner's death: transfer-on-death (ToD) deeds and deeds reserving a life estate.

Transfer-on-death

These deeds are available in the District of Columbia and these states: Alaska, Arizona, Arkansas, California, Colorado, Hawaii, Illinois, Indiana, Kansas, Minnesota, Missouri, Montana, Nebraska, Nevada, New Mexico, North Dakota, Ohio, Oklahoma, Oregon, South Dakota, Texas, Virginia, Washington, West Virginia, Wisconsin, and Wyoming.

ToDs are an inexpensive and simple way to convey ownership of real estate at the owner's death. A ToD deed, also known as a beneficiary deed, specifically names a beneficiary who will receive title to the real estate directly upon the death of the owner, bypassing probate. During the life of the owner, the named beneficiary has no ownership interest in the real estate, so the property is not subject to the beneficiary's liabilities. Also, the beneficiary designation can be changed at any time during the owner's lifetime. The control that the owner retains is a key difference from some other types of deeds, including life estates and joint tenancy with rights of survivorship.

One major disadvantage of ToD deeds is that the beneficiary cannot access the value of the asset if it's needed to provide for your care in the event of incapacity. If you own property and become incapacitated, it would require a court order and costly time-consuming legal proceedings to provide access to the property's equity. ToDs only convey property upon the owner's death, and that's too late for the property to be used as a beneficial asset during lifetime. Another drawback of a ToD deed is when the owner survives the beneficiary, the heirs of the beneficiary become the new owners if an updated deed is not recorded. They may not be the people you had in mind. People don't necessarily die in the order they are presumed to pass away.

Life estates

In this type of ownership, an individual property owner becomes a “life tenant,” retaining rights to utilize the property during his or her lifetime. A life estate deed, which is not reversible by the life tenant alone, is commonly used to enable a widowed spouse to pass on ownership of the family home, free of probate, to the adult children. The surviving spouse, in turn, maintains the right to reside in the home for life. In this type of ownership, a life estate deed can convey the asset upon the owner's death to one or more beneficiary, known as a “remainderman” or remainder beneficiary. One key strategy of a life estate is to keep the asset out of the life tenant's probate estate.

Another common use of a life estate is to shield the asset from Medicaid eligibility requirements and post-death Medicaid recovery efforts from the recipient's probate estate. Because the property avoids probate, the asset also can avoid recovery of Medicaid expenses by the state. Also, to be eligible for Medicaid's long-term care coverage, recipients are required to “spend down” their assets to just a few thousand dollars. Use of a life estate can disqualify the real estate from the spend down only after a five-year “lookback” period. Assets transferred during the lookback period cannot avoid the spend-down requirement. When a life estate is used, five years must pass before the asset can avoid the lookback period.

medicaid written on chalkboard

As with other types of ownership deeds, life estates can have unintended consequences when unexpected life events get in the way. As in other situations, the intentions of the remainderman can conflict with the wishes of the original owner. A life estate may be a shortcut to qualify for Medicaid, but its application as an estate planning tool can create unrelated difficulties. For example, if the life tenant becomes incapacitated and lacks a power of attorney, the remainderman cannot sell the real property to pay for the life tenant's needs or upkeep of the property. Conversely, the life tenant can't act if the remainderman becomes incapacitated. A life tenant, or a power of attorney who may act on behalf of an incapacitated life tenant, needs approval of the remainderman to sell or mortgage the property. In those situations, litigation would require that a decision be left to the unpredictable whims of a judge.

Only upon the death of the life tenant can the remainderman dispose of the property. By that time, it's too late for the property to benefit the life tenant. Also, the remainderman then can leave the asset to anyone of his or her choosing without regard to the life tenant's original wishes.

One type of life estate is a “Lady Bird” estate, also known as an enhanced life estate, which gives the original owner much more flexibility. In a Lady Bird deed, the original owner does not require the approval of the remainderman to sell or mortgage the property. A Lady Bird arrangement also avoids probate as the property transfers automatically to the remainderman upon death of the owner. However, Lady Bird deeds only are available in a handful of states.

What planning alternatives are available?

Deeds can present challenges for estate planning and weren't created with many of life's contingencies in mind. The use of a living revocable trust as part of a comprehensive estate plan avoids probate and can help deal with the shortcomings that deeds present. A trust and the appointment of a successor trustee can be utilized to address issues related to incapacity of property owners, the unexpected deaths of beneficiaries, ill-motivated family members, unanticipated changes in joint ownership, accessibility to equity and other matters.

A person's ownership stake in real property can be conveyed into a trust quickly and efficiently with a quitclaim deed. The trust creator, also known as the grantor, transfers ownership of assets, such as real property interests, into the trust. The grantor maintains control over the assets in the living trust as trustee and appoints successor and alternate trustees with fiduciary responsibilities to act on his or her behalf in the event of incapacity or death. Upon the grantor's death, the successor trustee then follows the grantor's instructions and predetermined wishes on administration of the trust and distribution of its assets.

Having a successor trustee to act as your agent with power of attorney can help keep your affairs out of the courthouse. With a successor trustee, there's no need to petition a court to appoint someone to act on your behalf or to forfeit your control over assets held in your trust. Your trustee will manage your real estate interests if you can't, providing highly desired flexibility in estate planning. If you are incapacitated and need access to liquidity to pay for long-term care, a successor trustee can make the decision to mortgage or sell off assets for your benefit. Trust instructions also can authorize a successor trustee to remove unintended beneficiaries. Also, because a trust is not part of a probate estate, grantors can avoid petitions by ill-motivated family members or others seeking to exert undue influence over an estate.

How do I create an estate plan?

There are numerous options and scenarios to consider when developing an estate plan that protects your legacy and achieves your objectives, and important decisions should be made with the advice of qualified lawyers and financial experts. Membership with Legacy Assurance Plan provides members with valuable resources and guidance to develop comprehensive estate plans that take life's contingencies into consideration and leave a positive impact for generations to come. Legacy Assurance Plan members also receive peace of mind that a team of trusted, experienced professionals will assist them in developing legal, financial and tax strategies that will meet their needs today and for years to come through periodic reviews.

This article is published by Legacy Assurance Plan and is intended for general informational purposes only. Some information may not apply to your situation. It does not, nor is it intended, to constitute legal advice. You should consult with an attorney regarding any specific questions about probate, living probate or other estate planning matters. Legacy Assurance Plan is an estate planning services company and is not a lawyer or law firm and is not engaged in the practice of law. For more information about this and other estate planning matters visit our website at legacyassuranceplan.com.

Phone - 844.445.3422
Email - info@legacyassuranceplan.com
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