CALIFORNIA TRANSFER ON DEATH DEEDS: The Good, the Bad and the Ugly
Sarah Spenless is an elderly widow with just one asset holding value: her home, which is worth $500,000. She would like her three children to inherit the home. She doesn’t want to spend the money to create a living trust, and she doesn’t want her children to have to go through a probate proceeding. With situations like hers in mind, the California legislature ushered in a new way to pass property to a beneficiary upon death: the California Transfer on Death Deed (“TOD deed”). Assembly Bill 139, effective January 1, 2016, was hailed by lawmakers as a way to avoid probate and the need to create a revocable living trust for the transfer of certain types of real property at the death of the property owner. Although transfer of property via a TOD deed may provide a shortcut to estate planning in a situation like Sarah’s, there is a very real potential for unintended and undesirable consequences from such a transfer for Sarah and her children. This post will explore the benefits and pitfalls of the TOD deed, both for property owners like Sarah and for others who may consider creating such deeds in lieu of traditional estate planning.
First: the specifics of the TOD deed. The property eligible to be transferred by a TOD deed is 1) real property improved with not less than one or more than four residential dwelling units, 2) a condominium unit, or 3) a single tract of agricultural property not more than 40 acres which is improved with single family residence The transferor must have capacity to execute a contract, and an eligible beneficiary must be a “person”, which includes individuals, a corporation, the government or a government agency, a trust, partnership, LLC, association or other entity. The beneficiary must be named and must be alive at the time of the death of the transferor. If more than one beneficiary is named, the property vests as a tenancy in common in equal shares, and if one beneficiary predeceases the transferor, the property passes to other beneficiaries in equal shares.
So far, the TOD Deed looks good for Sarah and her family. If Sarah has capacity, names her three children on the TOD Deed and records it properly, the property will pass to them upon her death. But if we look a little deeper, we will see that some potential issues are lurking.
The TOD deed recordation must be done on or before 60 days of execution, which can be after death. The TOD deed can be revoked at any time by a recorded document revoking it. What if Sarah does not record the deed after it is properly drafted, signed and notarized? The deed will be ineffective, which will then necessitate a probate for the change of ownership. What if Sarah executes the TOD deed, and then subsequently creates a living trust to set forth her (later) wishes of the passage of the property to her grandchildren. Even though it is clear what her later wishes are, if she dies and the TOD deed is recorded after the quitclaim deed, the TOD deed will control. What if Sarah doesn’t execute a living trust to provide for her grandchildren and one of her children predeceases her? There is no way for a grandchild to inherit their parent’s share through a TOD deed.
From these scenarios, it becomes clear that the most basic TOD deed situation can become complicated. But the really unfortunate part of the TOD deed is the potential for a huge burden to the beneficiary.
Property transferred via TOD deeds remain subject to existing liens and encumbrances. A beneficiary could have personal liability for the repayment of such encumbrances, and could potentially be liable for more than the value of the property received. Sarah’s children could be subject to claims by creditors, including Medi-Cal. Sarah’s personal representative will have three years to make a demand for restitution of the property to satisfy creditor claims, and her children could be required to transfer property back to her estate, plus any income received from the property. The law appears to provide no reimbursement mechanism for payments the children have made on encumbrances since date of death, and no credit for income taxes paid, or improvements that are not “significant”. If the children dispose of the property during the three year period, they can be required to transfer to Sarah’s estate an amount equal to the net value of property at the time of disposition, plus income received, plus interest at 10%. There is no reimbursement mechanism for payments on encumbrances, capital gains tax paid, income tax, or commissions or other costs of sale. If the children have improved the property they very well may not be entitled to reimbursement. If they have to defend collection efforts by the personal representative or creditors, their credit could suffer. The children are best advised to merely sit on the property until the three year period expires, which may be burdensome in and of itself. If such waiting seems untenable, there really is no recourse, because they cannot transfer the property to the personal representative unless the representative first demands restitution.
With such potential for negative consequences arising in the very scenario (Sarah’s) contemplated by the lawmakers who promulgated the TOD deed, what about property owners with more complex situations, such as families with minor children, second marriages and larger estates? Such property owners should clearly seek the advice of a competent estate planning firm (such as Bohm Wildish & Matsen, LLP) before resorting to the use of the California Transfer on Death Deed. In almost every circumstance, including Sarah’s, a revocable living trust is the most effective way to make sure that property is passed as the property owner and her beneficiaries would desire.