Prior to January 1, 2016, there were only three ways to effect a transfer of real property upon the death of a real property owner in California: (1) joint tenancy with right of survivorship; (2) trust transfer deed; or (3) probate. Each of these three options had pros and cons that had to be carefully considered when a real property owner was assessing his or her estate plan, but in late 2015, the California legislature enacted yet another way to handle these real property transfers - a new nonprobate transfer instrument for real estate called a "transfer on death" deed, which potentially offers a cost-effective and expeditious way of handling real property transfers at the death of an owner. Unfortunately, it also has downsides. This article will brush on the pros and cons of each potential option.
Joint tenancy with right of survivorship has always been a common type of titling for real property and other assets as between spouses or significant others, and will successfully transfer property from Spouse A to Spouse B upon the passing of Spouse A. The problem is not the passing of the first spouse to die as the property will simply go to the remaining spouse. The problem is: what happens when Spouse B passes away? If the asset is real estate in California, this would automatically necessitate the use of some type of probate proceeding to effectuate a transfer to the owner's beneficiaries. For some real property owners, the way around the probate was simply just to add his or her beneficiaries to title, also as joint tenants. Unfortunately, the decision to add a non-spouse or significant other to title is a decision which is fraught with concern.
First and foremost, by adding a loved one to title as a joint tenant, the owner is potentially subjecting his or her property to the creditors of his or her loved one. Second, there is a significant tax disadvantage to adding a loved one to title prior to passing. When a beneficiary inherits assets from a deceased owner, the beneficiary receives what is known as the "step up" in basis; essentially, the date of death value becomes the applicable value for purposes of calculating capital gains tax. This significant benefit is lost when a loved one is simply added to title. Third, by simply adding someone to title, a real property owner may be excluding other significant (and intended) heirs from their estate plan. For instance, if Husband and Wife add their two children to title. One of the children predeceases the Husband and Wife leaving children, those grandchildren will be disinherited because the joint tenancy will leave 100% of the property to the remaining child, even if the Husband and Wife would have had the predeceased child's share go to that child's children (their grandchildren).
While revocable living trusts (the "RLT") are the "gold standard" in estate planning, the disadvantage that they do have is that they require a little more effort and cost by the real property owner. The owner will first have to create a RLT (preferably with the assistance of a licensed attorney in the state in which they live or hold property) and then have to actually record a deed transferring the real estate to the RLT. Because attorney assistance is highly recommended, the cost is higher than the cost of just recording a joint tenancy deed. Further, upon the passing of the owner, there is some trust administration work that must be performed which generally delays the transfer of the real estate for a period of time. The benefits, however, far exceed the downsides as a properly drafted revocable living trust will avoid all of the pitfalls of the joint tenancy deed.
Another method that can be employed in California to transfer property from a real property owner to his/her beneficiaries is a probate proceeding. The disadvantages of probate are countless and include, but are not limited to, high attorney and executor's fees that are set by statute and are based on the gross value of the decedent's estate, not the net value; the California court system is impacted and it can take anywhere from one to two years or more to receive a distribution from the deceased owner; there is no privacy for the real property owner or his or her heirs as probate cases are matters of public record once filed with the court.
Because of the foregoing, the California legislature finally enacted legislation consistent with that of many of other jurisdictions that permit a nonprobate transfer instrument for real property. In California, this instrument is known as a "transfer on death" deed (the "TOD") and its function is to name a real property owner's beneficiaries entitled to receive the real estate upon the passing of the owner without the need of a trust, probate, or other type of joint tenancy deed. The concept of the TOD is similar to a life insurance policy with designated beneficiaries where the property is transferred upon the death of the owner to the listed beneficiary, thereby avoiding the cost and delay of probate, preserving the tax benefits of inheriting the property, and without the need of engaging in the time, effort and expense of formal estate planning with a revocable living trust.
The upside of the TOD is that it is revocable until the death of the transferor. The transferor can simply revoke the deed or record a new TOD, provided that the transferor has capacity to sign the new deed. The beneficiary would, however, still be liable for the debts on the property, such as mortgages and taxes, and would presumably have to satisfy the debts of the deceased property owner.
While the TOD in theory sounds like a great tool to effectuate a nonprobate transfer of real property, there are a multitude of concerns that only an estate planning attorney can properly explain. For instance, there is a huge potential for fraud and undue influence with the TOD. Consider the number of unscrupulous people who might take advantage of an aging real property owner and induce him or her to execute a TOD or the individual who is trying to avoid the expense of creating a RLT who executes a TOD without realizing the legal ramifications of the TOD or fully understanding the nature of how they work.
Because of the infancy of the law, there are many unknowns, for example it also is not clear how the TOD will affect reverse mortgages, which typically require the real property to be secured by the reverse mortgage to be sold upon the death of the property owner. Many of the elderly rely upon reverse mortgages to help them afford to continue living in their homes during retirement. Also, the question arises as to how much liability does the beneficiary of the TOD have to accept on behalf of the deceased property owner – is it limited to debts of the real property or does the liability extend to all the debts of the deceased – credit cards, judgments, child support obligations and so on. And these issues do not even begin to address issues concerning minors (who cannot legally own property under California law), special needs trust issues, and a plethora of other issues that are usually addressed in a revocable living trust. Because of these unknowns and the potential for fraud and undue influence, we believe that use of the TOD will likely result in an increase in probate proceedings while the public and attorneys get aquatinted to the new real estate transfer device.
The full ramifications of this legislation remain to be seen and only time will tell. We believe the TOD should only be used in very specific circumstances, and only upon the careful advice of an estate planning professional who knows the ins and outs of your family situation and can put the correct safeguards in place to avoid an unintended result. And, at the end of the day, the best and most effective way to avoid probate, manage the disposition of your assets and payment of your creditors remains through a revocable living trust.