Written by Mara M. Mahana
Clients planning their estates often want to keep matters as simple and straightforward as possible—both for themselves and for their heirs after they pass away. At first glance, California’s Revocable Transfer on Death Deed appears to be a simple solution which attorneys can offer clients in order to pass real property to heirs upon death without the expense of creating a will or trust, and without forcing the estate to go through the probate process in order to have the property distributed to their chosen heirs.
California’s Revocable Transfer on Death Deed law, which was made effective as of January 1, 2016 and codified in California Probate Code Sections 5600 through 5696, provides that a validly executed transfer on death deed in substantially the same form as required in Probate Code section 5642 transfers the real property to the named beneficiaries upon the grantor’s death. Per Probate Code Section 5610, this method can be used for single-family homes or condominiums, or a residence containing no more than four units.
Unfortunately, there are pitfalls to this approach, especially for clients who wish to retain the property’s low Proposition 13 property tax base and avoid property tax reassessment on the property. An attorney wishing to provide a simple solution to a client via a Revocable Transfer on Death Deed may instead inadvertently cause the client’s family to pay far more in property taxes. The low property tax base enjoyed by the parent can easily be partially or entirely lost for beneficiaries who inherit property via a Revocable Transfer on Death Deed.
Here is an illustrative hypothetical. A parent wishes to transfer the family home, worth $3 million, equally to her three children. The parent acquired the home 20 years ago for $1 million at a Proposition 13 property tax base value of $10,000. If the parent signs and records (within 60 days of signature) a Revocable Transfer on Death Deed naming her children as beneficiaries of the family home, the home will automatically be transferred to her three children upon her death pursuant to Probate Code Section 5652. The children will inherit the home at the same property tax base as their parent, since there is an exception to property tax reassessment for transfers from parents to children pursuant to Revenue and Taxation Code Section 63.1. The children can then co-own the property while paying the same base property tax value of $10,000 as their parent did, potentially saving them thousands of dollars in property taxes per year, since the property will not be reassessed for property tax purposes.
However, property transfers are rarely so simple. For example, what if the children do not want to co-own the home due to logistical or geographical concerns, do not get along well enough to co-own the home, or would prefer to have other estate assets in lieu of real property? If the home had been transferred to the children via a will or trust, the trustee or executor could arrange a distribution scheme which distributed the home to only the child or children who wanted it and who could then retain the low property tax base, and distribute other assets to the children who did not want the home. Alternatively, one child could buy the others out during the course of the estate or trust administration using their own funds or a private loan (per the Board of Equalization’s Property Tax Annotation 625.0235.005). Each of these approaches would accomplish the client’s and the family’s goals, and preserve the entire Proposition 13 tax base.
These alternatives are not available if a Revocable Transfer on Death Deed is used. Since the home passes to the children automatically upon death, the children cannot redistribute the home amongst themselves or buy the others out without triggering a property tax reassessment, since there is no exclusion from reassessment for transfers amongst siblings—only for transfers between parent and child (or grandparent and grandchild). Therefore, if two siblings buy one sibling out, one-third of the property would be reassessed, meaning that the property taxes would rise to $20,000 (the original $10,000 property tax base on two-thirds of the property, plus the $10,000 due from the reassessment of one-third of the property). The family would have lost a valuable opportunity to preserve the property’s lower Proposition 13 property tax base. The cost of this mistake greatly exceeds the cost of setting up an estate plan which would have preserved the ability to exempt the entire property from reassessment.
If a client’s goal is to pass property to children while preserving the maximum amount of family wealth, think twice about using a Revocable Transfer on Death Deed for real property in California—the result could be costly.