Thursday September 21, 2017
Article of the Month
Beneficiary Designations – Part III
Alongside wills and trusts, beneficiary designations are becoming increasingly popular as part of a complete estate plan. By simply filling out a beneficiary designation form, individuals can bypass probate and designate who will receive a specific asset upon their death. Today, a variety of assets can be transferred through a simple designation form, including bank accounts, stocks, bonds, retirement accounts, life insurance policies, commercial annuities and, in some states, even land, vehicles and boats.
While the process seems fairly straightforward, problems can arise and mistakes can be made when individuals execute these forms without a complete understanding of how they operate. Therefore, when completing a designation form, the owner should work with an advisor to ensure the form successfully achieves the owner's goals and to avoid common mistakes.
Part I discussed the different types of beneficiary designations and provided basic information in regard to how they operate. Part II explained the most common beneficiary designation mistakes and how to avoid them. This article will delve deeper into the complexities of beneficiary designation deeds, also called transfer on death (TOD) deeds, for real property and vehicles. Specifically, this article will explain the process required to set up a TOD designation, the implications for both the owner and the beneficiary and how to revoke a TOD designation. Next month, Part IV will present issues related to TOD deeds and how to avoid possible mistakes.
The information in this article reflects general trends among states. It is, however, important that professionals look to state law to determine the treatment of a transfer on death designation.
Transfer on Death Deed – Land
Non-probate transfers of particular assets through beneficiary designations have become increasingly common and recognized as effective tools in comprehensive estate plans. Retirement plans, life insurance, stock portfolios, bank accounts and commercial annuities are just some examples of assets that can be distributed easily and without probate through beneficiary designations. A transfer on death (TOD) deed enables an owner of real property to execute a deed during life naming the individual who will receive title to the property upon the owner's death. Just like a regular deed, the TOD deed must be prepared, signed, notarized and recorded by the property owner ("owner"). In addition, the deed must state that it will not go into effect until the owner's death. However, unlike regular deeds, TOD deeds can be revoked, as the beneficiary does not have a present interest in the property. Upon the death of the property owner, assuming there have been no revocations, the beneficiary will receive title to the property without the involvement of the probate court. If the decedent also listed the property in a will or trust, the TOD deed will control the distribution of the property regardless of when the will or trust was executed.
Not all states allow TOD deeds for real estate. While Missouri became the first state to allow TOD deeds in 1989, it wasn't until the early 2000s that the trend picked up speed and other states began to create mechanisms allowing non-probate transfers of real estate to a designated beneficiary. In 2009, the National Conference of Commissioners on Uniform State Law adopted the Uniform Real Property Transfer on Death Act ("Uniform Act"), prompting some states that did not already have statutes allowing TOD deeds to pass new laws. Currently, a little over half of all states allow TOD deeds. The states that currently allow TOD deeds are: Alaska, Arizona, Arkansas, California, Colorado, the District of Columbia, 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. Each state has its own rules and regulations governing the use of TOD deeds. As such, it is important to review the law of the state where the property is located before moving forward with a TOD deed.
Transfer on Death Deed – Vehicles
Additionally, some states allow car owners to name transfer on death beneficiaries for their vehicles. To be effective, the designation must be listed on the vehicle's certificate of title. Like TOD deeds for real property, designating a TOD beneficiary of a vehicle does not give the beneficiary a legal interest in the vehicle. The vehicle owner can still sell the vehicle, give it away or name someone else as the beneficiary.
Like TOD deeds for real property, not all states allow TOD designations for vehicles. The states that allow TOD vehicle registration include: Arizona, Arkansas, California, Connecticut, Delaware, Illinois, Indiana, Kansas, Missouri, Nebraska, Nevada, Ohio, Vermont and Virginia. In addition, California, Indiana and Ohio allow individuals to use TOD beneficiary designations for small boats.
Typically, a TOD deed must follow traditional deed formalities with respect to the recording process. The deed must be in writing, signed by the owner and include a legal description of the land (typically by a surveyor). Uniform Real Property Transfer on Death Act Sec. 9 (2009). Additionally, it must contain the names and addresses of the beneficiaries and state that the transfer of the owner's interest will not occur until the owner's death. However, unlike traditional deeds, delivery and acceptance by the designated beneficiary are not required for TOD deeds. Uniform Real Property Transfer on Death Act Sec. 10 (2009).
In many states, the TOD deed must be recorded prior to the death of the property owner. Other states have alternative timing requirements. For example, in California, the deed must be recorded within 60 days of being signed and notarized and it may be recorded even after the death of the transferor. Cal. Prob. Code Sec. 5626(a).
The process of executing a TOD deed has very different ramifications than the creation of a joint tenancy. When a joint tenancy deed is executed, the beneficiary becomes a full legal owner immediately. Unlike a joint tenancy, when a TOD deed is executed the beneficiary does not immediately receive a vested interest in the property. As such, the property owner is able to sell, refinance or change the beneficiary at any time. With a TOD deed, the designated beneficiary cannot challenge the owner's use, encumber the property or subject it to creditor's claims. Additionally, when a joint tenancy deed is executed, the original property owner is required to file a gift tax return. No such action is needed when a TOD deed is executed, because the beneficiary is not receiving a present interest in the property. Uniform Real Property Transfer on Death Act Sec. 12 (2009).
Because of the number of requirements and deed formalities, property owners should consult with an advisor to ensure that proper procedures are followed. Additionally, because laws vary by state, an attorney should look to the laws of the state in which the property is located to determine what is required.
TOD Deed Beneficiaries
The beneficiary of a TOD deed can be a person or an entity (e.g., an organization, institution, church, charity, etc.). Uniform Real Property Transfer on Death Act Sec. 2 (2009). While an owner can designate multiple beneficiaries, including primary and contingent beneficiaries, beneficiaries cannot be a designated class of persons in some states. For example, in California, if an owner executes a TOD deed and designates "all of my then living children" as the beneficiaries, the TOD deed will be invalid. Cal. Prob. Code Sec. 5622.
Beneficiaries must be specifically identified by name, address and, often, their relationship to the property owner. If, upon the owner's death, the beneficiary cannot be identified with certainty, then the property could be transferred to the owner's probate estate. As such, advisors should review the TOD deed before it is recorded to ensure that adequate identifying information has been provided.
When drafting a TOD deed, advisors should be mindful of the transferor's intent. While state law allows a property owner to leave varying shares of the real estate to different beneficiaries, the default under state law in many states is that the deed will grant equal shares to the TOD beneficiaries as tenants in common unless the deed specifically states otherwise. See Tex. Estate Code Sec. 114.103(a)(3) and Cal. Prob. Code Sec. 5642(b).
Jesse executes a transfer on death deed for his Texas home and names his sons, Wyatt, Billy and Butch as beneficiaries. Upon Jesse's death, Wyatt, Billy and Butch will each hold a 1/3 interest in the property as tenants in common unless the deed made specific provision to allocate the ownership differently.
As previously mentioned, the beneficiaries do not need to accept the transfer for the deed to be effective, as delivery and acceptance are not required. Thus, title to the TOD deed property will vest upon the owner's death. If desired, the beneficiary can disclaim the property interest (note that state law will govern the timing and requirements to properly disclaim the interest). In order for a beneficiary to claim title, most states require evidence of the owner's death, typically in the form of a death certificate or an affidavit of death. Cal. Prob. Code Sec. 210.
Because a TOD deed does not contain traditional deed warranties, the beneficiary will receive the title subject to all of the original owner's interests. Uniform Real Property Transfer on Death Act Sec. 13(b) (2009). Thus, all of the owner's previous mortgages, liens and judgments remain attached to the property and will be the responsibility of the beneficiary. This can create potential financial issues and risks for the beneficiary. Next month's article discusses this issue and explains how advisors can prevent potential financial hardships for TOD deed beneficiaries.
When a property owner executes a TOD deed, the owner has not made a completed gift for gift tax purposes (the beneficiary does not have a vested present interest). Uniform Real Property Transfer on Death Act Sec. 12 (2009). As such, the execution of the TOD deed does not have gift tax implications. The property will be considered part of the owner's estate at death for estate tax purposes. Note that if the owner designates a qualified charity as beneficiary of a TOD deed, the owner's estate will receive a charitable estate tax deduction.
The designated beneficiary of a TOD deed will receive a step-up in basis (i.e., the basis of the property will be equal to the property's value on the date of the owner's death). As such, the beneficiary may be able to avoid capital gains tax implications.
Restrictions on Property Type
Some states restrict the type of real property that can be transferred under a TOD deed. For example, in California a TOD deed "can only be used to transfer (1) a parcel of property that contains one to four residential dwelling units, (2) a condominium unit or (3) agricultural land of 40 acres or less, which contains a single family residence." Cal. Prob Code Sec. 5610. California does not permit the use of a TOD deed for commercial and industrial properties, vacant lots or plots of land or farmland that do not contain a single-family residence. In contrast, Texas law permits use of a TOD deed to transfer not only real property, but mineral and timber interests as well. Tex. Estate Code Sec. 114.002(a)(5).
As such, practitioners need to have a thorough understanding of this area of law in the state where the property is located to ensure that a TOD deed is appropriate. Additionally, advisors and landowners should monitor the property in case there is a change in the property's use. Issues could arise if use of the land changes such that a TOD deed would be ineffective upon the death of the owner.
Jesse executes a TOD deed in California for a parcel of land containing three residential dwellings. Jesse designated his two beloved nieces as the beneficiaries of the deed. As the years went by, Jesse decided to build two new homes on the property for his nieces to call home. Some time later, Jesse passed away. At the time of his death, the property subject to the TOD deed contained five residential dwellings. Because a TOD deed in California cannot be used for parcels of land containing more than four residential units, the designation would fail and the property would become part of Jesse's probate estate.
In order to avoid unintended consequences, it is important for property owners and their advisors to work together when executing TOD deeds to ensure that the deed will properly distribute the property.
Revocation of Deed
While state law may differ slightly, most states provide that a TOD deed can be revoked by taking one of three actions. Uniform Real Property Transfer on Death Act Sec. 11 (2009). First, the property owner may record a subsequent TOD deed. When there are two or more TOD deeds, the most recently executed deed is operative. To be effective, the deed must be properly recorded. Uniform Real Property Transfer on Death Act Sec. 11(A)(1)(a) (2009).
The second way to revoke a TOD deed is to execute an instrument of revocation (also referred to as a revocation deed). The revocation must occur before the death of the owner. Uniform Real Property Transfer on Death Act Sec. 11(A)(1)(b) (2009). The third way that a property owner can revoke a TOD deed is by selling or transferring all of the owner's interest in the property and properly recording the sale or transfer. Uniform Real Property Transfer on Death Act Sec. 11(A)(1)(c) (2009).
Note that some states may provide additional ways that a TOD deed may be revoked. For example, in Minnesota, Oregon and Texas, if a property owner names a spouse as beneficiary of a TOD deed and then they later divorce, a final judgment from the court dissolving the marriage will effectively revoke the TOD deed. Minn. Stat. Sec. 524.2-804; Or. Rev. Stat. Sec. 93.981 (2011); Tex. Estate Code Sec. 114.057(c). The judgment must be recorded in the county where the TOD deed is recorded prior to the death of the property owner. California does not provide a similar provision. The Uniform Act does not provide that a TOD deed will be revoked upon divorce. The Uniform Law Commission specifically provided that this issue was to be left to states to decide for themselves. Uniform Real Property Transfer on Death Act, Legislative Comm' to Sec. 13 (2009).
Most states follow the Uniform Act's guidance and set forth that the capacity required to make or revoke a TOD deed is the same capacity required to execute a will. Wash. Rev. Code Sec. 64.80.050; W. Va. Code Sec. 36-12-8; Uniform Real Property Transfer on Death Act Sec. 8 (2009). However, it is again worth checking the state's law on this issue, as some states adhere to stricter capacity standards. California, for example, follows a higher capacity standard, requiring that grantors in California possess capacity to contract when executing or revoking a TOD deed. Cal. Prob. Code Sec. 5620.
Whether or not an agent acting under a power-of-attorney can act to execute or revoke a TOD deed will depend on state agency laws (see Illinois Power of Attorney Act, 755 Ill. Comp. Stat. Sec. 45/2-9). It is clear that in some states, like Illinois and Texas, an individual holding a power of attorney cannot execute a TOD deed where the property owner lacks capacity. 810 Ill. Comp. Stat. Sec. 27/35 (2012); Tex. Estate Code Sec. 114.054(b). However, Minnesota does allow a TOD deed to be executed by an attorney-in-fact. Minn. Stat. Sec. 507.071-7. Therefore, it is important to research state agency law before allowing an agent of the property owner to execute a TOD deed.
Advantages of TOD Deeds
In the states that currently allow TOD deeds for real property, there are a number of benefits that may be realized. One of the obvious benefits is that a TOD deed allows real estate to be transferred without the often expensive and time-consuming probate court process. In contrast, when real property is transferred through a will or intestate succession, probate action in state court is required. While a TOD deed is not the only way to transfer real property at death without involving the probate court (e.g., joint tenancy or revocable trust), there are some reasons why individuals may benefit from, or prefer, a TOD deed.
First, unlike the creation of a joint tenancy, filling out a TOD deed does not give the beneficiary a vested, present interest in the property. Thus, there are no gift tax implications when executing a TOD deed. In contrast, creating a joint tenancy qualifies as a completed gift for gift tax purposes. Additionally, because the beneficiary does not have any legal rights in the TOD deed property, the property is not subject to the claims of the beneficiary's creditors and the owner has flexibility to change the beneficiary designation at any time. Alternatively, when a joint tenancy is created, the action is irrevocable and, because the new joint tenant is added to the title, any judgments, liens or debts of the new joint tenant could attach to the property.
Additionally, when taking into account the tax implications for the beneficiary, a TOD deed is likely preferable to a joint tenancy. When property passes to a beneficiary under a TOD deed, the beneficiary receives a step-up in basis (i.e., the basis will equal the value of the property on the date of the original owner's death). Alternatively, when an individual is named a joint tenant during the owner's lifetime, the individual receives a carry-over basis (i.e., the basis of the original owner) for their undivided interest in the property.
A revocable trust is an additional tool in the estate planning toolbox. Designating a beneficiary under the terms of a revocable trust will not create a completed gift for gift tax purposes and can avoid probate upon the owner's death. However, the fees associated with drafting an effective trust can often make this option less than ideal for individuals with limited means or for those whose only asset is real property. Additionally, using both a revocable trust and a TOD deed may be an effective means of drafting a comprehensive estate plan. Advisors should work with their clients to find a solution that will successfully meet the needs and goals of their clients.
A properly executed TOD deed can be an effective means of transferring real property to loved ones. Each state, however, has its own rules governing the use of TOD deeds. Because states differ in regard to the types of property that can be transferred, the capacity required and revocation standards, it is important to look to the laws of the state where the property is located when preparing a TOD deed. Additionally, due to the state law distinctions, complexities and requirements, someone considering a TOD deed to transfer property should work with an advisor who is knowledgeable about the various state law requirements to ensure that the property is transferred as intended and the goals of the owner are accomplished.