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Alex Baker: Real estate transactions, litigation, tax liens and estate planning ... Super Lawyers Rising Stars honoree

 

 

Real Estate Law | January 2013

Beneficiary Deeds: A Superior Alternative to Joint Tenancy?

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 of survivorship.

The Risks of Joint Tenancy

Often called the “poor man’s estate plan,” 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 Gordon’s wishes.

  • Second, Gordon’s 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, Lyle’s buyer.

  • Third, the vacant lot became part of Lyle’s assets, and is subject to any claims of Lyle’s creditors. In a successful legal action against Lyle, they could assume his interest in the property and become Gordon’s new co-owners.

Alternative: Beneficiary Deed

Joint tenancy with rights of survivorship was not Gordon’s only option. Instead, he could have executed a beneficiary deed to convey ownership in the vacant lot to Lyle upon Gordon’s 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 Lyle’s assets and is safe from creditor claims.

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 Gordon’s lifetime.

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.

Tax Basis

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 owner’s 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 tenant’s basis is unchanged, resulting in a larger taxable gain upon sale.

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 $100,000.

  • 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 Harold’s stepped-up basis (i.e., half of the $300,000 value at the time of his death), and $50,000 for Martin’s basis (i.e., the difference between the value of Martin’s 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 Harold’s 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.