Effective January 1, 2016, recent California legislation created, at least temporarily, the right to record “revocable transfer on death deeds” that allow for the transfer of real property at death without using a will or trust.
Background – Pay or Transfer on Death Bank/Investment Accounts
Most already understand the concept of “transfer on death” (TOD) which is also known as a “pay on death” (POD) designation when designated on bank and investment accounts. The designation allows the named beneficiaries on the TOD designation to appear before the bank or institution and claim title to the account following the death of all account holders. The holder of the account may revoke or modify an existing account TOD designation at any time before death.
For example, where the holder uses a TOD to designate his or her children as successors, upon the occurrence of an event such as a subsequent child birth or death an account holder’s child, it is expected that the account holder will affirmatively act to update his or her TOD designation. Accordingly, if no change is made, the account is considered held solely by the surviving designated children.
On a TOD designation, the account owner does not have to leave the account equally if more than one beneficiary is named. The account holder may designate the proportions specified by the owner in the beneficiary designation form.
A TOD designation does not avoid issues of capacity with respect to a TOD designee. If the designee is a minor or incapacitated, it will probably be required to have a court designate a custodian or trustee for the minor or disabled designee.
On the other hand, if the TOD designation is not corrected to reflect a change, it is presumed that the account holder expected a deceased designee’s interest to lapse, and that there should be no addition. This means that if there is any failure to correct for an error, it is left to the heirs to endeavor to try to voluntarily resolve any omission. Finally, the TOD designation may supersede general bequests under a personal will or trust, but it does not limit the right for a beneficiary under a will or trust to pursue court action to correct an error; however, such disputes can become very costly.
Revocable Transfer on Death
First adopted by Missouri in 1989, the revocable TOD deed is intended to allow real property to be cost effectively transferred without a probate or use of a will or trust. Like the designations for bank/investment accounts, the grantee-beneficiary has no vested interest in the property until the actual death of the current owner. A revocable TOD deed is executed and recorded, designating beneficiaries who will take real property upon the owner’s death. The owner may modify or revoke the designation by a later recording.
On the other hand, a revocable TOD deed differs from a TOD designation on bank and investment accounts. In particular, California legislation requires the following:
- First, the revocable TOD deed, unlike a bank or investment account TOD designation must be notarized and recorded within 60 days of execution. Otherwise the revocable TOD deed will be void.
- Second, the revocable TOD deed must meet certain statutory specifications as to its contents to be valid.
- Third, a revocable TOD deed is unavailable to real property held in joint tenancy, community property with right of survivorship (CPWROS) or in trust. Title must be converted into either a one owner individually or tenant-in-common (including as community property, without survivorship rights), as applicable to be available. If the title designation is impermissible, then the revocable TOD deed is void and ineffective.
- Fourth, the revocable TOD deed is only effective after January 1, 2016, and only if recorded by January 1, 2021.
While a revocable TOD deed may be of interest to some clients, it is unlikely to replace either a will or a revocable living trust. While supported in its 2006 Report by the California Law Revision Commission, for its efficiency, commentary urging using a revocable TOD deed in lieu of a personal will or trust is generally minimally poor advice and possibly negligence or malpractice if it infers one should not have a personal will or a trust for estate planning purposes. (See Revocable Transfer on Death (TOD) Deed, 36 Cal. L. Revision Comm’n Reports 103 (2006).)
In particular, a revocable TOD deed will not work for any long-term succession plan as it cannot anticipate changes in events. Real property tends not only to be a substantial asset within an estate, but the handling of its disposition by TOD is very restricted and provides no direction as to the testator’s expectations, if there is a disagreement by the successors. For example, a revocable TOD deed is not allowed to designate succession either (i) “a deceased beneficiary’s issue by right of representation” or (ii) one’s “children” to allow some flexibility. Only the actual names of the beneficiaries may be designated. Accordingly, if one of several designated beneficiaries on a revocable TOD deed dies, then his or her share must pass to the remaining designated surviving beneficiaries – all who take their interests equally as tenants in common. If that was not what had been intended, then a revocable TOD deed shouldn’t be used.
Furthermore, unlike accounts that are actively managed, revocable TOD deeds are unlikely to be monitored by owners. This means that owner neglect in updating revocable TOD deeds may later result in serious problems. The designations may have results inconsistent with later intentions and become the subject of disputes. This problem becomes exacerbated as the owner must have legal capacity to make a change.
Further Concerns with Revocable TOD Deeds
Unfortunately, revocable TOD deeds may create a number of unexpected problems.
- A revocable TOD deed does not avoid the need for a written will. A revocable TOD deed may create a false sense of security to skip a written will. If the sole designated beneficiary in a revocable TOD deed disclaims the transfer or dies, the transfer will fail. If the owner did not have a written will, then the owner was intestate. Distribution of his estate will occur through probate courts under intestacy laws.
- A revocable TOD deed cannot provide clean title to a bona fide purchaser for value for the first 120 days following the transfer to designated beneficiaries. Accordingly, it cannot be used as an available asset, whether by financing or sale to address the final obligations of the decedent. If sold prior to the passage of 120 days, a bona fide purchaser may still lose title under a later title dispute between the estate and the designated death beneficiaries. (Probate Code Section 5694).
- Indeed, in the same vein, a revocable TOD deed may create some rather nasty issues between surviving spouses and the designated beneficiaries under the deed at any time prior to the passage of the three-year statute of limitations for filing claims beginning with the filing of an affidavit by the designated beneficiaries. An administrator or any interested party to file a legal action within three years, which may include a lis pendens – by law, the three-year period may not be “tolled”. The consequences of an action can be quite messy.
- Problems in Second Marriages: Any resolution between the surviving spouse and the children from the prior marriage would have all sorts of issues to resolve. For example, assume that husband died leaving by way of a revocable TOD deed the personal residence to his children. However, the home was occupied by the husband and his second wife, recently married. The husband also just signed a will granting life interest in “all his property” to his spouse. The written will also contains a limited no-contest clause. The surviving spouse was unaware of the prior revocable TOD deed. In this situation, the children may decide to assert their rights under the revocable TOD deed, whether or not they learned of a contrary will. But, the wife may challenge any action by the children. If the children prevail, they have an action for recovery for lost rent, but the wife may claim a recovery for later improvements made. If the wife prevails, the children have no recovery and must also convince the court that they are not disinherited under the no-contest provisions– having probable cause to challenge the will.
- A revocable TOD deed does not avoid the owner’s creditors. Creditors may seek collection against the designated beneficiaries as to secured and unsecured obligations of the original owner. The revocable TOD transfer affords no protection from creditors, with the exception that if a statutory probate creditors’ claims period is commenced and administered, then each beneficiary is then accountable to the estate of the owner, rather than to the creditors.
- A revocable TOD deed, if incorrect, cannot be resolved informally after the owner’s death without tax consequences. A correction to insert an omitted owner will not qualify for the parent-child transfer exclusion from reassessment, which might otherwise be available.
- A revocable TOD deed is more easily challenged for competency. For a revocable TOD deed, the level capacity required is the ability to ‘contract,’ a higher standard than for wills.
On the other hand, at least as some good news, a revocable TOD deed has no income, estate or property tax consequences upon its execution and recording. The property owner retains all rights and continues to be treated as owner for all tax purposes, during the owner’s life. Indeed, the property owner need not tell the designated beneficiary (or any other family member for that matter) about the revocable TOD deed and the beneficiary designation.
For California property tax purposes, no change of ownership results from the recording of a revocable TOD deed as the recording does not constitute a conveyance given that it is revocable.
On the other hand, upon the death of the owner, the deed does convey title upon filing of an affidavit. The designated beneficiary must record under Probate Code Section 210 an affidavit of death of the owner to take title. Other standard notices apply such as notifying the State Department of Health Care Services and filing a change of ownership notice under R&T Code Section 480. The transfer by the revocable TOD deed then conveys all income to the new owners.
In addition, upon the death of the owner, a change of ownership will arise, unless an exemption, such as the parent-child transfer exclusion is available. As long as there is no informal attempt to correct an omitted child, the unlimited principal residence and $1 million lifetime assessed value allowance for other property may be available.
The TOD Deed itself does not carry any unique analysis with respect to estate taxes or tax basis upon the death of the account holder. The basis step-up rules apply upon the owner’s death, and estate taxes, and valuation are determined under the same rules applicable to other property transferred upon death.
It is not expected that a revocable TOD deed should ever be used for larger estates. For estate planning purposes, the revocable TOD deed was intended to avoid only probate administration, not estate taxes. It should not be considered a tool to reduce estate taxes. In addition, an executor would have a right to seek recovery from the designated beneficiaries for their share of estate taxes, if any on the value of property received.
The foregoing provides only a summary of many of the significant concerns, and before drafting a revocable TOD deed, one should consult an attorney familiar with estate planning. While a revocable TOD deed creates some excitement as a new estate planning tool it should be used very sparingly and should not replace having a will. For estates of any significance, to avoid probate administration, a trust remains the better option in most cases.