A Transfer on Death (TOD) deed, while offering the advantage of avoiding probate, comes with several significant disadvantages and potential complications that can affect both the grantor and the beneficiaries. Understanding these drawbacks is crucial before deciding if a TOD deed is the right estate planning tool for your circumstances.
Here are the primary disadvantages of a Transfer on Death deed:
1. Potential Tax Implications
While a TOD deed bypasses the probate process, it does not necessarily exempt the property or the beneficiaries from all tax liabilities. The tax implications can be complex and are a common area of misunderstanding.
- Estate Taxes: For estates exceeding certain federal (and some state) thresholds, the property transferred via a TOD deed is still considered part of the decedent's taxable estate and may be subject to estate taxes.
- Capital Gains Tax Basis: Fortunately, properties transferred via a TOD deed usually receive a "stepped-up" basis equal to the property's fair market value on the date of the grantor's death. This often helps reduce capital gains tax if the beneficiary sells the property soon after inheriting it. However, beneficiaries need to be aware of how this basis works and its implications if they hold the property for an extended period before selling.
- Inheritance Taxes: Some states impose an inheritance tax, which is levied on the beneficiary receiving the property, not on the estate. A TOD deed does not avoid these state-specific taxes.
2. Challenges with Beneficiary Modification
Although a TOD deed is generally revocable by the grantor during their lifetime, there can be restriction on the grantor's ability to modify beneficiaries in practical terms, leading to unforeseen issues.
- Incapacity: If the grantor becomes incapacitated (e.g., due to illness or injury) and has not put a durable power of attorney or trust in place, they may lose the legal capacity to revoke or modify the TOD deed, even if their wishes change.
- Forgetting or Neglecting Updates: Grantors might create a TOD deed and then forget about it or fail to update it as life circumstances change (e.g., beneficiaries pass away, relationships sour, new family members are born). This oversight can lead to the property going to unintended individuals.
- Multiple Grantors: If multiple individuals own the property as joint tenants and create a TOD deed, specific state laws might dictate how and when modifications can be made, potentially requiring agreement from all surviving grantors.
3. Risk of Unintentional Disinheritance
A TOD deed names specific beneficiaries, which can inadvertently lead to the unintentional disinheritance of family members. This is particularly problematic if circumstances change or if the grantor has complex familial relationships.
- Deceased Beneficiary: If a named beneficiary predeceases the grantor, and no contingent beneficiary is named on the deed, the property may revert to the grantor's estate. This could then necessitate probate for that property, defeating one of the main purposes of the TOD deed, or lead to it passing according to intestacy laws (dying without a will), potentially to individuals the grantor did not intend.
- "Per Stirpes" Issues: Unlike a will or trust, TOD deeds typically don't include "per stirpes" language, which dictates that if a named beneficiary dies, their share goes to their descendants. Without this, if a named child dies, their children (the grantor's grandchildren) might receive nothing from the TOD property.
- Unequal Distribution/Assumptions: If a grantor names only one child, assuming that child will share the property with siblings, there is no legal obligation for them to do so. This can create significant family disputes.
4. Increased Responsibilities and Liabilities for Beneficiaries
Upon the grantor's death, the increased responsibilities and liabilities on the beneficiary can be substantial, as they inherit the property "as is."
- Existing Liens and Debts: The beneficiary inherits the property subject to any existing mortgages, liens, or judgments against it. They become responsible for these financial obligations.
- Property Costs: Beneficiaries are responsible for ongoing property taxes, insurance, maintenance costs, and utility bills from the moment of transfer. If the property requires significant repairs or has deferred maintenance, it can be a considerable financial burden.
- Creditor Claims: While TOD deeds typically avoid probate, some states allow creditors of the deceased to make claims against the property transferred via a TOD deed for a certain period after death, especially if the rest of the estate is insufficient to cover debts.
Summary of Disadvantages
To summarize, while TOD deeds offer a streamlined way to transfer property outside of probate, their complexities can lead to unexpected challenges:
| Disadvantage Category | Explanation |
|---|---|
| Potential Tax Complexities | Despite avoiding probate, properties transferred via TOD deeds can still be subject to federal estate taxes, state inheritance taxes, and require understanding of capital gains tax basis rules. |
| Challenges with Modification | Although revocable, practical difficulties arise if the grantor becomes incapacitated, fails to update the deed as circumstances change, or faces specific legal constraints with co-ownership. |
| Risk of Unintended Disinheritance | If named beneficiaries predecease the grantor without clear contingent provisions, or if the grantor's informal intentions regarding sharing are not legally binding, actual heirs may be overlooked. |
| Increased Beneficiary Burden | The named beneficiary inherits the property with all its associated burdens, including existing mortgages, liens, ongoing property taxes, maintenance costs, and potential creditor claims. |
Careful consideration of these disadvantages and consulting with an estate planning attorney is advisable to determine if a TOD deed aligns with your overall estate plan and goals.
