Most owners of Texas real estate have two estate planning goals:
- They want to retain as much control over the property as possible during life; and
- They want the property to pass to family members or other designated beneficiaries at death without the expense or hassle of probate.
Texas law provides several ways to accomplish these goals. While a living trust provides the most flexibility, it is also the most expensive and administratively complex option. For Texas property owners looking for a less expensive and complex option, Texas law recognizes several types of probate avoidance deeds. The two most common probate avoidance deeds are transfer-on-death deeds (TOD deeds) and lady bird deeds.
Because both lady bird deeds and TOD deeds can accomplish estate planning goals, and because Texas law recognizes both types of deeds, questions often arise about which deed form to use. This article discusses the pros and cons of TOD deeds and lady bird deeds and summarizes the situations where one might be a better choice than the other. (Hint: Texas lady bird deeds are usually the better choice.)
A Preliminary Note on Title Insurance
The analysis below considers the important role of title insurance in real estate transactions. Sometimes the legality of a deed is not enough. A deed can effectively transfer valid title without transferring insurable title. If title is not insurable, then the property is unmarketable until additional steps are taken to clear title to the property. Property with unmarketable title is worth less than property with marketable title.
It is important to consider whether title insurance companies will write a policy on property transferred using the specific deed type in question. For example, quitclaim deeds are disfavored in Texas due to the reluctance of title insurance companies to insure them (even though title insurance companies in many other states do so without hesitation). Because insurability of title is an important practical consideration that can affect the value of the property, this article includes it in the analysis.
Overview of Texas Lady Bird Deeds
A Texas lady bird deed form is the more traditional probate avoidance tool. Texas lady bird deeds have long been recognized by title insurance companies, real estate lawyers, and even the Texas Medicaid rules as an effective means for retaining control during life and avoiding probate at death.
Texas lady bird deeds work by conveying the property to new owners—called remainder beneficiaries—at the death of the current owner—called the life tenant. The current owner/life tenant reserves an interest called a life estate that allows the life tenant to use the property during his or her life. This life estate is enhanced in the sense that it allows the life tenant to retain complete control over the property during life, including the ability to unwind the life estate. This enhanced control gives the lady bird deed is proper legal name—enhanced life estate deed.
Lady bird deeds are only used in Texas, Florida, Michigan, Vermont, and West Virginia. They are not authorized by statute, but have a solid basis in common law and practice and have been recognized by Medicaid agencies in these states. Although lady bird deeds are not specifically authorized by the Texas Statutes, they are well-established estate planning tools for Texas property owners.
Overview of Transfer-on-Death Deeds
Transfer-on-death (TOD) deeds are a newer form of deed that is rapidly gaining in popularity among state legislatures. They were first authorized in Texas in 2015.
A Texas TOD deed form allows a Texas property owner to designate a beneficiary to receive property at death. It functions in much the same way as a payable-on-death designation on a bank account or life insurance policy. When the property owner dies, the named beneficiary inherits the property by operation of law, without the need for probate.
Unlike like lady bird deeds, which have their origin in common law and customary practice, Texas TOD deeds are specifically authorized by statute. Although they were designed for use by self-represented Texas property owners, many attorneys have started to include TOD deeds in their estate planning toolkit.
A Comparison of TOD Deeds and Lady Bird Deeds
Although TOD deeds and lady bird deeds have similar goals, there are several differences that may support using one or the other, depending on the circumstances.
Unresolved Creditor Issues for Two Years After the Owner’s Death
Under Section 114.106 of the Texas Estates Code, if a deceased owner’s estate cannot pay the debts of the estate, the personal representative of the estate may enforce the claim against the property transferred by TOD deed. Under this rule, creditors must bring the claim within two years of the date of the owner’s death.
The two-year creditor period may create title insurance issues. If the property is not homestead property (which is exempt from creditor claims), some title insurance companies take the position that the title is not insurable for two years after the transferor’s death. This two-year period gives creditors a chance to file a claim and, conversely, may restrict the beneficiary’s ability to sell or mortgage the property.
Other title insurance companies will issue the policy with exceptions. For example, WFG National Title Insurance Company issued an Underwriting Bulletin to its agents on July 18, 2016, directing agents to include an exception from title insurance for claims arising from the TOD deed. It would be up to the buyer or the lender to decide whether to accept the policy with this exception.
Depending on the circumstances, the title insurance underwriter may also accept indemnities from the beneficiaries or examine the assets of the decedent. Beyond that, the only way to shorten this two-year period is to resolve creditor claims in a probate proceeding—the very thing that the TOD deed is designed to avoid.
Lady bird deeds have no statutory creditor period. Unless the lady bird deed was fraudulently executed, it is exempt from creditor claims. Because lady bird deeds have historically been acceptable to title insurance companies and do not come with a statutory two-year creditor period, they are the better choice for passing insurable title. This is particularly true if the beneficiaries may sell or mortgage the property within the two-year period following the owner’s death and the property is not homestead property.
Winner: Lady bird deed
Warranty of Title
Section 114.013(3) of the Texas Estates Code provides that a TOD deed may not contain a warranty of title. Even if the deed is drafted to include an explicit warranty of title, the warranty of title is voided by the statute. There is no way to convey property by TOD deed with a warranty of title.
Lady bird deeds do not have this limitation. Depending on the circumstances, a Texas lady bird deed could be drafted as a deed without warranty, general warranty deed, or special warranty deed.
The presence or lack of a warranty of title has important title insurance implications. If property is transferred using a lady bird deed with a warranty of title, the new owners—in this case, the beneficiaries—can file a claim for breach of warranty. As long as the original owner had a title insurance policy, the beneficiaries can look to that policy for protection against title problems. This protection is lost with a TOD deed, which provides no warranty of title. If it turns out that there is a problem with title the property, beneficiaries that inherit under a TOD deed have no recourse.
This difference has also been noted by title insurance companies. If a TOD deed is involved, I have heard reports that some title insurance companies require a full thirty-five-year title search and require the future deed from the beneficiary to include a general or special warranty of title.
Winner: Lady bird deed
Flexibility in Designating Beneficiaries and Survivorship Rights
Under Section 114.103(a)(3) of the Texas Estates Code, beneficiaries that inherit under a TOD deed take the property “in equal and undivided shares with no right of survivorship.” This has two implications:
- It is impossible to use a TOD deed to transfer property in unequal interests. For example, a grandfather could not leave one-half of his property to his son and one-quarter of the property to each of his two grandchildren. If a TOD deed is used, each beneficiary inherits an equal interest.
- It is impossible to use a TOD deed to transfer property with a right of survivorship in the new owners. A father that wanted to leave property to his two children with a right of survivorship—so that the surviving child would inherit the property on the death of the first child to die—could not do so with a TOD deed.
A Texas lady bird deed does not have these limitations. A lady bird deed can be custom-drafted to create unequal ownership interests or a right of survivorship in the beneficiaries. If either of these is a concern, a lady bird deed is the better choice.
Winner: Lady bird deed
Ability to Name Contingent Beneficiaries
Sometimes Texas property owners want to leave property to one or more beneficiaries (primary beneficiaries), but also name other beneficiaries (alternate beneficiaries) to inherit the property if the primary beneficiaries are deceased. Alternate beneficiaries are permitted in the Texas TOD deed statute and may be used on Texas TOD deeds.
Texas lady bird deeds are not based in statute and have no express authority for naming alternate or contingent beneficiaries. Depending on the circumstances, the same results may be accomplished with a lady bird deed by creating a joint tenancy with right of survivorship among the primary beneficiaries and naming the alternate beneficiaries as remainder beneficiaries. But if the owner wants to name alternate beneficiaries without creating a joint tenancy with right of survivorship during life, a TOD deed may be a better choice.
Winner: Transfer-on-death deed
Medicaid Planning: Five-Year Lookback and Medicaid Recovery
As discussed in more detail at Texas Deeds and Medicaid Asset Protection, there are two Medicaid considerations when using an estate planning deed to transfer Texas real estate: The five-year lookback period for Medicaid qualification and the estate recovery program for deceased Medicaid recipients.
Five-Year Lookback Period. When a person applies for Medicaid in Texas, he or she must disclose any transfers during the five years prior to the Medicaid application. The Texas Health and Human Services Commission will penalize the application for any uncompensated transfers during that five-year period. Neither a lady bird deed nor a TOD deed is considered a transfer for purposes of calculating the penalty. Lady bird deeds escape penalty under Section I-3000 of the Texas Medicaid for the Elderly and People with Disabilities (MEPD) Handbook and TOD deeds escape penalty under Section 114.101(4) of the Texas Estates Code.
Estate Recovery. When a Medicaid recipient dies, the Texas Health and Human Services Commission can look to his or her estate to recover funds spent for the Medicaid recipient during his or her life. But the Commission can only look to the assets of the deceased recipient’s probate estate. Because both lady bird deeds and TOD deeds remove the assets from the probate estate, both are effective at limiting estate recovery under the current rules.
Both lady bird deeds and TOD deeds can be useful for Medicaid planning. Neither has a clear advantage over the other for purposes of the five-year lookback or Medicaid estate recovery.
Powers of Attorney
The Texas TOD statute is clear that a transfer-on-death deed may not be created using a power of attorney. Lady bird deeds can be signed by an agent under a valid power of attorney.
Winner: Lady bird deed
Which Type of Deed to Use
As the above analysis illustrates, there are only a few circumstances where a Texas TOD deed is a better choice than a Texas lady bird deed. A lady bird deed is usually a better choice than a TOD deed for Texas property owners that want to retain control during life and leave property to family members at death.