Most people are interested in protecting their wealth for the sake of their loved ones after they are gone. When a loved one dies, even in the best of circumstances, the events can be overwhelming to process. We all could use a reprieve from the added stresses that can tag along, like the sticker shock from funeral expenses and the time and cost of administering an estate. Thankfully, Texas law has certain tools available to avoid probate, or at least simplify it.
There is much interest of late in tools such as Gift Deeds and Lady Bird Deeds, two such tools to transfer property and avoid probate. Each deed’s utility is distinct, and each should be employed in different scenarios. So, what exactly are these instruments, and when should we use them?
A Gift Deed transfers property with no consideration, meaning the giver receives nothing in return for the transfer. This comes as a great benefit to the one receiving, except you must beware of the IRS and possible tax implications to the giver and the receiver. Gift Deeds may trigger an obligation to report the gift on a Gift Tax Return (check with your CPA to see whether this is applicable to you). A possible detriment of a Gift Deed is that the gift receiver obtains the property at the tax basis of the giver. This means that if you receive property by Gift Deed and then want to sell it after it has increased in value, the IRS may tax you on the amount of the property appreciated in value since the original grantor came to own the property. For example, Grandpa bought property for $50,000.00 (his basis) and gives the property to you by Gift Deed. You hold the property for a few years and decide to sell it for $100,000.00. The IRS may tax you on the gain between Grandpa’s basis and the property’s current sale price. This might be pertinent to consider if you are being given property. On the other hand, a Gift Deed may be a beneficial way for a giver to avoid estate tax if they have a large estate and wish to begin gifting items from their estate to downsize.
In contrast, when you receive property via Lady Bird Deed, you receive a “step-up” in basis, meaning the basis on which the property is taxed when sold is that of the value when you came into ownership, not your grantor. In most cases, this means a lower tax burden for the receiver. In the example used above, if Grandpa deeded the property to you by Lady Bird Deed instead of Gift Deed, Grandpa’s basis of $50,000.00 is “stepped-up” to the present value of the property at the time Grandpa dies and the property is fully deeded to you.
Before we get ahead of ourselves, let’s discuss this other option more clearly.
A Lady Bird Deed, technically referred to as an Enhanced Life Estate Deed, is used for a Grantor to transfer property to someone while still retaining a life estate in the property. But what is a Life Estate?
A Life Estate is an interest in property for the duration of the holder’s life. However, a Lady Bird Deed reserves to the grantor an Enhanced Life Estate right. For example, if Grant conveys rights in his property to his daughter Beni while reserving an Enhanced Life Estate interest, this means that Beni has no rights to the property, until Grant dies. For the duration of Grant’s lifetime, he has full control of the property; he can rent it out and make improvements, he can borrow against it, cancel or revoke the Lady Bird Deed, or even sell the property someone else. The transfer of possessory rights to Beni are complete only at Grant’s death, and until then, Grant can do whatever he wants with the property—even sell it—without Beni’s say-so.
If Beni were to inherit the property instead under Grant’s will, she would have to wait for his designated executor to go to the judge and probate the will. With a Lady Bird Deed, she could own and enjoy or sell the property immediately after Grant passed. But with an Enhanced Life Estate Deed—the Lady Bird Deed‑—there is an even greater benefit to both Grant and Beni.
Imagine that Grant used a Life Estate Deed, and before Grant passed, he applied for Medicaid. He qualified and was on Medicaid for 2 years and then died. Upon his death, Medicaid may seek reimbursement from Grant’s estate for expenses using the Medicaid Estate Recovery Program (“MERP”). If Grant gave the property to Beni using a non-Lady Bird Deed in the 5 years prior to his death or via his Will, Medicaid may pursue the value of the house and/or may seek to recover the house for reimbursement of its expenses.
Suppose Grant used a Lady Bird Deed to transfer the property to Beni instead. This small distinction means the transfer is exempt from the MERP look-back rules. Grant is then able to transfer the house to Beni upon his death without the house being subject to MERP.
There are more aspects of both methods discussed here that could be helpful to think through before transferring your property. It is always best to visit with an attorney and a CPA versed in these various tools and planning methods. Give us a call at (254) 300-7909 and we would be happy to discuss options that might fit your needs and estate planning goals.