Why Transfer on Death Deeds Don’t Work in California
We are taking a brief break from the series on why every family needs a comprehensive estate plan in California to talk about deeds. In particular - transfer on death deeds. In California, some people are tempted to use a Transfer on Death (TOD) deed as a quick and inexpensive way to avoid probate. On the surface, it sounds appealing: you sign a deed that names who should inherit your home when you die, and the property skips probate. Simple, right? Unfortunately, in practice TOD deeds often create more problems than they solve. Here’s why you should think twice before using one.
No Beneficiary Protections
Who is receiving the real property? Is the person a minor child? What if that person is deceased and you forgot to update the deed? What happens if two people are deeded the property? How is it divided? Who decides?
A TOD deed passes property directly to the named beneficiary. There’s no trustee to manage it, no creditor protection, and no safeguards if your beneficiary is a minor, disabled, or financially irresponsible. How does this all get resolved? Probate court! You tried to avoid it, but actually it’s just created litigation for your loved ones in court.
Restrictions on Sale
Some title companies and lenders are reluctant to deal with properties transferred by TOD deed because of the risk of future claims. That can make it harder for your beneficiary to sell or refinance the home. A properly funded trust, on the other hand, provides clear title and avoids these issues.
Legal Unknowns
California’s TOD deed law has been extended and revised multiple times, and its long-term future is uncertain. Depending on legislative changes, your TOD deed could expire or be subject to new requirements.
Tax Implications
Recently, we have seen some TOD deeds from married couples in which each spouse transfers on death their share of the property to their kids. This is a big tax problem - for both capital gains and for property tax.
For capital gains, unless there is a prenup agreement or other considerations, generally married couples should own property as community property. We’ll be posting about capital gains taxes specifically in weeks to come but the idea is that (for example) if you buy a house and sell it, you pay capital gains taxes on the increased value. If you buy a house and die, then the capital gains are “reset” as of the date of your death so that whoever receives the property pays capital gains only from the date of death forward. If a married couple owns a property as joint tenants (or owns less than the full property), the capital gains only resets for the portion of the property owned by the spouse who died. However, if a couple owns a property as community property (unique to California and a few other states), then the property value is reset 100% at the time each spouse dies. Meaning, the surviving spouse would pay no capital gains from the date of purchase to the date of death of the first spouse — at the time that they choose to sell the property. In this example, if one spouse is giving away their share at their death, then they inherently do not own as community property.
For property tax, in California, thanks to Prop 19, the property tax can be preserved in a parent to child transfer only if the property is the parents’ primary residence and becomes the child’s primary residence. In a circumstance where one spouse gives away their share to their kids at their death, that means that an adult child has to move back in with surviving spouse/parent or else the property tax is going to go up for half the property.
It’s hard to explain in short blog post what unnecessary tax disasters this could cause for families. But both of these taxes can have huge implications for families — and the surviving spouse is going to bear the brunt of it for no good reason.
Why is a Living Trust better than a TOD deed?
While TOD deeds may seem attractive because they’re inexpensive, they often create costly complications later. A comprehensive estate plan that includes a revocable living trust gives you:
Comprehensive coverage of all your assets
Protection for beneficiaries who are young or vulnerable
Flexibility to update your plan as life changes
Estate tax planning (federal, not California)
Capital gains tax planning (state and federal)
Property tax planning (county)
Clear instructions to avoid family conflict
Reliable probate avoidance
Back up plans in case things go amiss
Incapacity planning
This is why most estate planning attorneys in California err on the side of a comprehensive estate plan instead of short, seemingly sweet solutions. It’s important to contact a local attorney if you have any questions about TOD deeds or your own estate planning goals.