"Lady Bird" Deeds & Revoking a Revocable Trust - A Case Study

he transfer-on-death (TOD) deed isn't new; it is sometimes referred to as the "Lady Bird Deed" because it was reportedly used by former President Lyndon B. Johnson for his wife many years ago.¹ Nor are TOD deeds a rapidly developing trend; only a handful of states have recognized this arrangement thus far.

But there are reasons to believe that a trend is gathering momentum. A few states, such as Texas and Florida have permitted certain transfer-on-death deeds for a number of years, but over the past decade, eight states, Arizona, Arkansas, Colorado, Kansas, Missouri, Nevada, New Mexico, and Ohio, have specifically adopted new laws allowing the TOD deeds to be used as means of avoiding probate for the family home, and a uniform legislation is not far behind.²

With the exception of Ohio, these TOD deed-friendly states surround Texas where the idea was born. But this southwestern experiment won't stop people in the other 42 states from asking questions about TOD deeds.

According to legend, former President Johnson once used the transfer-on-death deed to transfer some property to his wife, the former First Lady.³

Here's why the transaction is attractive. The owner can deed the property to a beneficiary while retaining a life estate. In fact, this arrangement is now referred to in various ways such as the "enhanced life estate deed," or the "revocable transfer on death deed."

The Benefits:

A deed can be prepared inexpensively.

The owner continues to utilize the property for life.

The property is not subject to the liens of creditors of the beneficiary.

The property passes at death to the beneficiary potentially with a stepped-up basis for capital gains purposes.

Unlike an irrevocable transfer of a remainder interest in trust or adding a name to a deed as a joint owner, the TOD deed can be revoked prior to death without the remainderman's permission.

At the owner's death, the life interest is extinguished and the remainder interest takes effect, allowing the transfer of the property to take place automatically, without probate expenses or delays.

The expenses associated with maintaining a home during a lengthy probate process are avoided as well.

The Drawbacks:

Complications may arise when there are multiple owners or multiple beneficiaries.

The deeded property remains in the owner's estate for estate tax purposes.

If the deed is recorded, it reveals publicly who will receive the property at death.

The life tenant could mortgage, encumber, or convey the property before the beneficiary receives it.

The beneficiary could predecease the life tenant and a title company could require probate of the beneficiary's estate by interpreting the remainder interest as being vested subject to divestment.

The life tenant could predecease the remainderman causing judgments against the remainderman to attach to the property.

In the absence of case law or statutes in certain jurisdictions, title companies may not answer specific issues, leaving unresolved questions.

The Time Is Right

Perhaps the time is right for transfer-on-death deeds. People already use TOD arrangements for bank accounts, securities, insurance, retirement accounts, and even vehicles.

For real estate, joint ownership with right of survivorship has essentially the same effect but once joint ownership is created, it can't be revoked. Similarly, transfer of a remainder interest in trust while retaining a life estate is used and follows the same pattern, but without the benefits of revocability or the stepped-up basis.

Moreover, real estate has become more of a commodity in recent years. Based on anecdotal reports, homes in some regions are being sold every five years on average. The availability of capital gains exemptions every two years enables rapid turn over. And the rise of investment and retirement accounts has reduced the role of real estate as a proportion of estates.

The advent of a longer look-back period for Medicaid qualification may encourage new approaches to retaining life estates and transferring real estate at death. Retaining a life estate will not generally preclude Medicaid qualification but a caveat is in order. It is not certain how specific state codes will be applied, but if the creator of a TOD deed retains the right to revoke it, that property may be a resource subject to future liens for Medicaid purposes.

On May 19, 2006, the Joint Editorial Board for Uniform Trust and Estate Acts, with the support of the Joint Editorial Board for Uniform Real Property Acts, requested the appointment of a Drafting Committee to prepare a free-standing Uniform Transfer On Death Real Property Registration Act which could then be adopted as a portion of the Uniform Probate Code.⁴

California is now considering the revocable transfer-on-death deed. Public comment on TOD deeds was solicited by the California Law Revision Commission with a deadline of October 10, 2006, and the results have identified several critical issues that should be considered.⁵

The California Judges Association weighed in against revocable TOD deeds. They provide an example of a transferor who executes the deed but then has a change of heart and does not record it. Can the beneficiary who finds the deed then record it, notwithstanding the intent of the transferor?

Other questions were raised as well:

How is a TOD arrangement recorded with respect to creditors?

Will TODs cause a wave of litigation between co-owners? Should a TOD deed become irrevocable after the death of the first co-owner?

The interests of children in an estate may not be adequately protected where the family home is the main asset of the estate and is transferred by TOD deed.

There is potential for fraud, such as where a TOD signed in extremis.

Users of the TOD deed may fail to realize the exposure of the assets to Medicaid recovery after death.

After a revocable TOD deed is executed, can it be revoked by a valid will that specifically purports to revoke the deed or which specifically conveys that same property?

See You Later

We are early in the discussion of transfer-on-death deeds, but their usefulness and simplicity make them attractive, and the promulgation of uniform laws may advance this technique to the forefront of estate planning over the next decade.

TECHNICAL REFERENCES

¹ Most articles refer to Lady Bird Johnson, but in a 2002 Elder Law newsletter it was suggested that the name arose from a hypothetical example from an elder-law article that referred to the creator of a deed as "Ladybird." If true, then life imitates art.

² The exact sequence of adoption of TOD deed laws was Missouri (1989), Kansas (1997), Ohio (2000), New Mexico (2001), Arizona (2002), Nevada 2003 and amended 2005), Colorado (2004), and Arkansas (2005). Similar legislation is being proposed in Oklahoma.

³ Claudia "Lady Bird" Johnson received her life-long nickname as an infant when a nursemaid commented that the child was "as pretty as a ladybird." Now 94 and known for founding the Lady Bird Johnson Wildflower Center, the former First Lady has been protected by Secret Service longer than anyone else in history. Wikipedia.

⁴ A 57-page analysis with text of the eight state statutes from the Joint Editorial Board for Uniform Trust and Estate Acts is available at www. nccusl.org/nccusl/scope&Program/TODRealPropt_ScopeRqst_051906.pdf.

⁵ The 97-page report and recommendations of the California Law Revision Commission can be found online at: http://www.clrc.ca.gov/pub/Misc-Report/ TR-Bene Deed.pdf.

Case Study: Revoking a Revocable Trust

Even the best of trusts may come to the end of its useful life. But when is that? How can that determination be made? Are there any signs that can help one anticipate when a trust will reach that point? What transitional issues arise?

Let's consider a factual setting based on actual cases to identify some important points.

Last of the Spinsters: Two elderly sisters had never married nor had children. They pooled their resources and set up a revocable living trust which was coordinated with their wills.

At the death of the first sister, all assets would go to the trust on behalf of the surviving sister. On the death of the second sister, the nieces and nephews of the two sisters would benefit.

The trust documents consist of the original 23-page revocable living trust from 1985, a seven-page amendment from 1991, and a six-page will that pours all assets into the living trust. Collateral documents include three different powers of attorney each consisting of two or three pages and providing powers to various agents and trustees that were executed over the past 22 years.

When the trust was planned out in 1985, Grantor was 68 and her sister was 72. Their nephew serving as trustee was 49. Flash forward 22 years to 2007. The older sister died five years ago. She lived to be 89. The nephew lived to be 71. Grantor/Testator, now 90 years old, is the survivor of the two sisters.

The trust assets now consist of $250,000 of various investments that are grouped in four investment accounts, a certificate of deposit, and two bank accounts. The accounts name the revocable living trust as the sole beneficiary.

Testator is currently living in an assisted-living facility that charges $50,000 annually. She is tapping into her investments for all of that funding. Although Testator has full comprehension of who her heirs are and what her intentions are, she has trouble grasping how much money she has or how long it will last.

The oldest of her nephews had always managed the finances. Now that nephew has predeceased his aunt, the surviving Grantor/Testator. The group of surviving grandnephews and grandnieces are trying to assist Testator.

Medicaid Planning: For Medicaid planning purposes this estate has already missed a golden opportunity. Upon the death of the Grantor's sister five years ago, when there was $500,000 of assets, a portion of the trust could have been made irrevocable or transferred to another family trust. The objective is to limit Grantor's control so that the trust assets are not an available resource for Medicaid purposes.

Care must be taken not to transfer all available assets because the Grantor will not immediately qualify for Medicaid and will need sufficient funds to get by during the look-back period. The look-back period for gifts in trust had been five years prior to the recent change that extended the Medicaid qualification look-back period for outright gifts from three years to five years.

Suppose at the death of her sister five years ago, Grantor, then as the sole remaining Trustee, decided to split the funds and place $250,000 in an irrevocable trust and use the remaining $250,000 for assisted-living expenses. Five years later (i.e., now), the Grantor would qualify for Medicaid and $250,000 would be protected.

In fact, by making outright gifts of $350,000 five years ago, the Grantor would have been able to spend down the remaining $150,000 at the assisted-living facility and would have qualified for Medicaid two years ago.

Having failed to take any action, the assets remained in the revocable living trust and remained an available resource for purposes of Medicaid. With $250,000 left as resource and expenses of $50,000 annually, Grantor will not qualify for Medicaid for five years, yet at the current rate of expenditures, Grantor will have exhausted the entirety of her assets over the next five years or sooner. The remaining planning strategies for Grantor involve spending down assets for a prepaid funeral and other permitted expenses.

Cumbersome Documents: A total of 43 pages in six documents is not a catastrophe by any means and in the context of an effective trust arrangement that provides protections and/or increases yields or reduces taxes, a few extra pages of documentation is irrelevant. But for an elderly person with very simple and limited assets, the paperwork and documentation that are the legacy of a once-effective trust may now become a relevant concern.

In the case described above, the various documents were submitted to a probate court in State X upon the death of the first sister/Grantor. The probate court took weeks to read and compare the documents. Photocopying the 43 pages for the 14 beneficiaries of the will cost $60, the postage cost an extra $50. The estate's attorney and accountant each spent time researching the documents, costing the estate an extra $650. Filing the will and trust documents for probate cost an extra $200.

And every time there is a question about the will, the family is faced with the same difficulties, delay and expense. These are all picayune matters, and yet, collectively, become an unnecessary burden on smaller estates. Such documents could easily be updated and streamlined and at least provide the same peace of mind the family had when the former documents were relevant and effective.