Transfer on Death Tax Implications

A Transfer on Death (TOD) deed allows property owners to name a beneficiary or beneficiaries to directly inherit their property upon the owner’s death, without the need for probate court proceedings. The property is transferred directly to the beneficiary and bypasses the often lengthy and costly probate process.

What Is a Transfer on Death (TOD) Deed?

A Transfer on Death Deed (TOD), also known as a “beneficiary deed” is a way to title real estate to your loved ones or beneficiaries without (1) needing to create an entire trust, which can sometimes be a bit more complicated, and (2) avoid probate, which can be costly, timely, and often a stressful process. The property remains yours during your lifetime and you continue to control it (refinance, sell, rent out, or do anything else with real property that you choose) until you pass away, at which point the deed automatically transfers to the name of your beneficiary. Moreover, TOD Deeds are revocable, which means you can amend or revoke them at any time.

However, one thing it doesn’t do is avoid taxes. In fact, upon the owner’s death estate and inheritance tax applies. Thus, it is important to review the tax implications of these accounts to determine if this is the most advantageous way to transfer funds to beneficiaries.

Read on to learn more about the tax implications of TOD Deeds and if you have additional questions, speak with an Orange County probate attorney.

Types of TOD Deeds

Different states tend to have different names for a Transfer on Death Deed, some of which may be:

• Transfer-on-Death Instrument
• Deed Upon Death
• Beneficiary Deed
• TODD
• Lady Bird Deed
• Enhanced Life Estate Deed

Regardless of what it is called in your state, the TOD Deed’s main purpose is to avoid the probate process.

Tax Implications of Transfer on Death Deeds

Keep in mind that while you are alive, TOD Deeds have no impact on, nor benefit for that matter, for your beneficiary. He or she has no legal rights to the property until after you pass away, which means you pay the property taxes on it until you die. Hence, it is not an effective tax beneficial tool. Nonetheless, the threshold is quite high, and the majority of beneficiaries do not pay taxes on TOD Deeds. Overall, a TOD Deed can be a great way to ensure your beneficiaries get the inheritance you intend for them.

Income Taxes

Income taxes, as typical, will be your responsibility during your lifetime, given you have full ownership and control of assets in a transfer on death account. You receive all interest, dividends, and other income, and thus, you are responsible for paying federal taxes and state taxes on such taxable income.

Estate Taxes

A handful of states collect estate taxes at time of death. In 2024, the federal estate tax exemption is $13.61 million dollars for individuals and $27.22 million for married couples. Estates valued under that threshold do not pay estate tax and no IRS filing is required. The federal estate tax is paid on the fair market value of the taxable estate that exceeds that threshold amount.

A transfer on death account is not a trust or an estate plan, it is part of the decedent’s estate and it does not protect against or minimize estate taxes.

To learn about the benefit of TOD deeds versus forming an estate plan, contact an Orange County estate planning attorney.

Property Taxes

The property may be reassessed at current market value upon the owner’s death, potentially increasing property taxes. However, laws vary by state, and some states have provisions to limit reassessment if the property is inherited by certain family members or used as a primary residence.

Inheritance Taxes

Now, unlike an estate tax, beneficiaries pay an inheritance tax and it is usually due shortly after funds are received by the beneficiary. It is a state-imposed tax that is paid when receiving money or property from a deceased person’s estate. Only a handful of states still collect an inheritance tax and the exclusion amount is nonetheless relatively high, so most beneficiaries will avoid inheritance tax.

Additionally, certain relationships between the deceased and beneficiary are exempt or qualify for a reduction in the amount of inheritance tax owed. For example, a surviving spouse who inherits property from their deceased spouse is exempt from inheritance tax, if they reside in one of few states that still impose it.

As of 2024, six stated impose an inheritance tax. These states are:

1. Iowa
2. Kentucky
3. Maryland
4. Nebraska
5. New Jersey
6. Pennsylvania

Capital Gains Taxes

Capital gains are the difference between the sale price of an investment and the original purchase price (the cost basis) of that investment. When you create a transfer on death account by naming a beneficiary to your brokerage account, the law sets the inheritor’s tax basis as the value at the time of the previous owner’s date of death which, in turn, offers considerable capital gains benefits.

For example, if you purchased 100 shares of stock for $5 each and several years later, upon your death, the same stock is valued at $50 a share, with a transfer on death account, the beneficiary would receive stock valued at $50 a share. The capital gains from the original cost basis ($5) would no longer be owed if the beneficiary were to sell the stock at its current fair market value.

The named beneficiary can generally sell the property immediately after inheriting it. However, they should be aware of potential capital gains tax based on the property’s stepped-up basis, which is the market value of the property at the owner’s death. The step-up in basis means that the property’s tax basis is updated to its fair market value at the owner’s death. If the property has appreciated, this can significantly reduce the capital gains tax owed if the beneficiary sells the property.

Avoid Probate With a Transfer on Death Deed

Avoiding probate is perhaps the biggest perk to a Transfer on Death Deed. Setting up such a deed is pretty simple, and though the process may vary slightly from state to state, here are some general basic steps to follow:

• Get Your State-Specific Deed Form. Look up the requirements for the state the property is in. Many states have state-specific forms or language that must be used in order to be valid.
• Decide on Your Beneficiary. Be specific. Don’t say “my children.” Instead, use their full names. You may also want to consider naming an alternate beneficiary in case your chosen one doesn’t survive you. Additionally, if you have more than one beneficiary, be sure to include how the property will be titled in their names. For example, if you use “Joint Tenants,” that means when one dies, the surviving beneficiary will become the owner. Be sure to check what language your state recognizes as some states won’t accept “Joint Tenants.”
• Include a Description of the Property. An existing current deed will have the exact legal property description and it should be copied exactly as is shown. Make sure to double-check and compare it against the original for accuracy.
• Sign the New Deed. If you are the only owner, your signature will suffice. Nonetheless, you should check to see if you’re in a community property state, if so, you should have your spouse sign as well.
• Record the Deed. If you do not record a TOD Deed, it is not valid. To record it, you need to find your Land Records office in the county the property is in. The office name varies from state to state. This entity can also be recognized as the County Recorder, Registrar of Deeds or Land Registry, to name a few. If you’re unsure about where to file the deed, simply call your local courthouse and they should be able to guide you with the office you need.

FAQs for a Transfer on Death Deed

What happens if a TOD deed beneficiary dies?

If a beneficiary of a Transfer on Death (TOD) deed dies, the outcome depends on the specific terms of the deed and state law. Here are some general scenarios that could occur:

1. Alternate Beneficiaries Specified: If the TOD deed specifies alternate beneficiaries in the event the primary beneficiary predeceases the property owner, the property would pass to the alternate beneficiary or beneficiaries as outlined in the deed.
2. No Alternate Beneficiaries: If no alternate beneficiaries are specified and the primary beneficiary predeceases the property owner, the property typically reverts to the estate of the property owner upon their death. It would then be distributed according to their will or, if there is no will, according to the state’s intestacy laws.
3. Survivorship Requirement: Some TOD deeds include a survivorship requirement, meaning the beneficiary must survive the owner by a certain period (e.g., 120 hours) to inherit the property. If the beneficiary dies within this period, the property might pass as if the beneficiary had predeceased the owner.
4. Joint Beneficiaries: If there are multiple beneficiaries listed and one dies, the share of the deceased beneficiary usually passes to the surviving beneficiaries, unless the deed specifies otherwise. However, this can vary based on the terms of the deed and local laws.

Estate planning attorneys can provide guidance tailored to the specific circumstances and applicable state laws, ensuring that the property owner’s intentions are clearly documented and legally enforceable. Always review and update estate planning documents regularly, especially after significant life events like the death of a beneficiary.

What happens if the TOD deed is revoked?

The owner can revoke a TOD deed at any time before their death. The revocation must be done according to the legal requirements of the state where the property is located, usually by recording a revocation document or a new deed.

What should property owners consider before setting up a TOD deed?

Property owners should consider their overall estate planning goals, the potential tax implications, the relationship with the beneficiary, and the possibility of future changes in their wishes. It’s also crucial to understand the legal process for setting up, revoking, or changing a TOD deed, as well as any impact on eligibility for Medicaid or other benefits.

What is the difference between a TOD deed and a Lady Bird deeds?

The key differences between the two deeds include:

• Legal Recognition: The most significant difference is the legal recognition and availability of each deed type, with Lady Bird deeds being limited to a few states: Florida, Texas, Michigan, Vermont, and West Virginia.
• Medicaid Planning: Lady Bird deeds are particularly noted for their use in Medicaid planning, as they can help the property owner qualify for Medicaid by excluding the property from their countable assets, while still allowing them to retain control and the ability to sell the property.
• Estate Recovery: Another advantage of Lady Bird deeds is the potential protection against estate recovery, where the state seeks to recoup Medicaid expenses from the estate of the deceased.