Real Estate Law | January 2013
Beneficiary Deeds: A Superior Alternative to Joint
In titling real property, beneficiary deeds
offer important advantages with respect to control,
flexibility, creditor protection and taxation.
From an estate planning standpoint, the manner in which
real property is titled can be a valuable tool in avoiding probate, minimizing
legal and other costs, and achieving a seamless transfer of ownership. However,
if done incorrectly, relying on the method of ownership in conveying real
property can inflict potentially disastrous results for the property owner and
the person to whom he or she wishes to leave the property.
Consider this common example. Gordon owns a vacant lot
in central Phoenix. He wants to leave the property to his son, Lyle. As part of
his estate planning, Gordon conveys title to the property from himself, as the
sole owner, to himself and Lyle, who take ownership as joint tenants with rights
The Risks of Joint Tenancy
Often called the ďpoor manís estate plan,Ē joint tenancy
is inexpensive to create, is very effective in avoiding probate, and is
appropriate in most marital situations in which property is owned jointly by a
husband and wife.
However, as the continuation of our example illustrates,
when the joint tenants are not married to each other, this ownership option is
subject to serious drawbacks.
When he re-titled his property to himself and Lyle as
joint tenants, Gordon transferred actual ownership and, in the process, exposed
himself to substantial risk:
First, Lyle gained the rights to deal with his
property interest as he wishes, to the same extent as Gordon. Those rights
include selling his interest therein, forcing Gordon to share the property with
a new co-owner against Gordonís wishes.
Second, Gordonís transfer to joint tenancy is
irrevocable; i.e., it cannot be undone if Gordon has a change of heart, and he
is stuck with Lyle or, worse, Lyleís buyer.
Third, the vacant lot became part of Lyleís assets,
and is subject to any claims of Lyleís creditors. In a successful legal action
against Lyle, they could assume his interest in the property and become Gordonís
Alternative: Beneficiary Deed
Joint tenancy with rights of survivorship was not
Gordonís only option. Instead, he could have executed a beneficiary deed to
convey ownership in the vacant lot to Lyle upon Gordonís death. In contrast to
joint tenancy, the advantages of a beneficiary deed are significant:
From a current interest standpoint, the
beneficiary deed does not grant any sort of ownership to Lyle.
Gordon can revoke the beneficiary deed at any time
prior to his death.
Since Lyle is not an owner of the property while
Gordon is alive, the property is not part of Lyleís assets and is safe from
Put another way, the beneficiary deed allows Gordon to
convey his real property to Lyle outside of probate or the use of a trust, while
retaining all rights and ownership associated with the property during Gordonís
Gift Tax Issues
As stated above, executing a deed adding another
individual to the title as joint tenancy with rights of survivorship is
tantamount to conveying an ownership interest in the real property. This raises
an issue not mentioned earlier, i.e., the transfer qualifies as a gift for
estate planning purposes. Upon the execution of the deed conveying such an
interest, the owner is required to pay all applicable gift taxes associated with
that transfer. Under certain circumstances, this can be significant.
On the other hand, because a beneficiary deed does not
grant an actual ownership interest in the property at the time of execution, the
owner has gifted absolutely nothing to the designated beneficiary and therefore
incurs no gift tax liability.
Perhaps the most significant issue relates to the basis
allotted to the property for tax purposes.
In a joint tenancy situation, when one of the owners
dies, the basis for that ownerís percentage ownership in the property will bump
up to the value of the property at the time of death (on a proportional basis).
The surviving tenantís basis is unchanged, resulting in a larger taxable gain
With a beneficiary deed, the entire basis of the
property will bump up to the value at death, which in most cases will result in
lower taxes when the property is sold.
Consider this scenario:
Harold buy a piece of real property for $100,000
and takes title as a single individual.
He gifts a 50% interest to Martin via a deed as joint
tenants with rights of survivorship. The basis in the property remains at
When Harold dies, the property is worth $300,000.
Martin, who is now the sole owner, eventually sells
the property for $300,000.
The basis for tax purposes will be $200,000: $150,000
for Haroldís stepped-up basis (i.e., half of the $300,000 value at the time of
his death), and $50,000 for Martinís basis (i.e., the difference between the
value of Martinís half-interest at the time of the gift from Harold and his half
of the sale price). The result: a taxable amount of $100,000 (the $300,000 sales
price less the $200,000 basis).
If the owner had utilized a beneficiary deed, on the
other hand, the basis for sale purposes would have been $300,000 (i.e., the
stepped-up basis in the property at the time of Haroldís gift to Martin),
resulting in a zero taxable amount. The tax effect of the beneficiary deed upon
the sale of the property is quite significant, and the tax saving increases as
the value of the property increases.
A Worthy Alternative
The net effect of all of this is that, when utilized
correctly (with special consideration being paid to the necessary language of
the deed and method of recordation), beneficiary deeds offer the owner of
property the most effective manner of passing property to a specified
beneficiary outside of probate or a trust.
Alex Baker represents clients throughout the
Phoenix area, including north Scottsdale, Cave Creek and Carefree.