The Dangers of Estate Planning by Deed

A key estate planning objective for many individuals is to avoid the need for a probate administration of their estate – particularly real estate such as their home —  after their death.  Why?  Because probate costs money and it diverts funds otherwise distributable to the decedent’s intended beneficiaries to court costs and attorney fees.

There are several techniques that can be utilized to avoid a probate of one’s estate.  One common technique is to utilize a revocable trust (also known as a “living trust”).  In this type of trust, the grantor establishes the trust in a written trust agreement, names a trustee or trustees and specifies his or her desires as to the distribution of assets upon their death.  The revocable trust is coupled with a “pour-over” will that serves as a catch-all if any assets are not retitled into the name of the trust prior to the grantor’s death.

Use of a revocable trust is an accepted estate planning strategy that, if properly prepared and funded, will avoid the need for a probate administration of the grantor’s estate.  It is not, however, inexpensive.

In an effort to avoid the cost of having a revocable trust prepared, some people – including some attorneys – have devised what they perceive to be more cost-effective alternatives.  One such alternative commonly used is a flat out conveyance of the property from the owner to the owner’s desired beneficiaries (typically children) with the owner/grantor retaining a life estate in the property.  Upon the grantor’s death, title to the property passes to the remaindermen without the need for a probate.  However, a gift tax return would most likely need to be prepared and filed.

A common problem of this life estate/remainder interest structure arises when the life tenant wishes to sell the property during his or her lifetime.  If this situation arises, the life tenant is only entitled to a portion of the sale proceeds based upon the value of the life estate; the balance of the proceeds would belong to the holders of the remainder interest.  Further, in the case of the sale of a home, while the life tenant could utilize the capital gains exemption by rolling over his or her share of the proceeds into a new home, the remaindermen will be subject to capital gains tax for their portion of the proceeds received.

In an effort to resolve this common dilemma, Minnesota law now allows a “transfer on death deed”, or TODD.  With a TODD, the grantor executes and records the deed conveying the property to his or her desired beneficiary(ies), but the conveyance is not effective until the grantor’s death.  The significance of the TODD’s revocability is that the grantor can revoke the deed during his or her lifetime and thus avoid the capital gains tax headache described above relative to the life estate/remainder interest structure.

Sounds great, right?  Think again.  My colleague, Glenn Kessel, described to me a matter he handled whereby the TODD was recorded but the grantee named in the TODD predeceased the grantor and the grantor failed to revoke the TODD prior to the grantor’s death.  Guess what the result was?  The property passed to the grantee’s issue under the anti-lapse provisions (Minnesota Statute Section 507.071, Subd. 11), but – yes, you guessed it, a probate was required in order to have the court determine the deceased grantee’s heirs in order to effect the conveyance to them.

What’s the moral of this story?  It is not that a revocable trust agreement is a panacea for all estate planning matters.  Rather, it is that consultation with a knowledgeable estate planning attorney that addresses all the scenarios and consequences of a proposed plan always beats a shotgun plan, “estate planning by deed” included.