Many states, Michigan and Arizona included, have provided a means to be able to transfer real property to a designated beneficiary upon the death of the owner. The method of doing so is known as an Enhanced Life Estate Deed and is most often referred to as a LADY BIRD Deed as in Lady Bird Johnson. Although I have yet to find any connection between Lady Bird Johnson and this very effective tool in the arsenal of Estate Planners.
The Lady Bird Deed is a way to transfer real property to another person on a contingent basis, while retaining lifetime use of the property, and ability to convey it, for oneself. The transfer to the contingent grantee is not complete until the death of the grantor, making the ladybird deed essentially a beneficiary designation for real property.
Ladybird deeds have been described as giving something with one hand, while keeping the power to snatch it back with the other. Why would anyone want to do this? Well, actually, ladybird deeds offer a number of advantages, particularly for single people.
Ladybird Deeds for Medicaid Planning and to Avoid Probate
One popular use of ladybird deeds is to help the grantor of the property become eligible for Medicaid funds for long-term care without losing a homestead to the need to "spend down" assets. Medicaid "looks back" at transfers for years before eligibility is sought, so a grantor cannot simply transfer a home outright to a friend or family member. Because a ladybird deed retains an unrestricted interest in the real property, it is not considered to be a lifetime transfer of the property.
The grantor can execute the ladybird deed either before or after qualifying for Medicaid. Because the ladybird deed transfers the property on the grantor's death, the property doesn't enter the grantor's estate, and cannot be recovered under the Estate Recovery laws.
In addition to Medicaid planning, ladybird deeds can also be used as an estate planning tool for both single individuals and married couples Ladybird deeds, living trusts, beneficiary designations, and other transfer-on-death tools, can be used to bypass the probate process. Even with all of these devices in place, however, it is always advisable for one to have a simple will in place.
Capital Gains Tax Benefits for Grantees of Ladybird Deeds
In addition to the planning benefits for the grantor of a Lady Bird deed noted above, there are also benefits for the recipient, or grantee. In addition to the planning benefits for the grantor of a Lady Bird deed, there are also benefits for the recipient.
Perhaps the most significant is the stepped-up cost basis for the property, minimizing any capital gains tax for the grantee if he or she sells the property. With a Lady Bird deed, the grantee or remainder person does not have an ownership interest in the real property until the grantor's death, so their basis will be the fair market value of the property as of that date.
To illustrate this, let's say the grantor bought a house. At the time of executing the Lady Bird deed, the house was worth $400,000. At the time of the grantor's death, the house was worth $500,000. When the grantee sold it, it was worth $600,000. If the grantor had simply transferred the house to the grantee, the grantee would pay capital gains tax on the difference between$400,000 (FMV at time of transfer) and $600,000 (FMV at time of sale). Because of the Lady Bird deed, he will only pay capital gains tax on the difference between $500,000 (FMV at the time of grantor's death) and $600,000 (FMV at time of sale).
Limitations of Ladybird Deeds
Ladybird deeds do have many advantages, but there are limitations as well.
One limitation of the Lady Bird deed is that, due to the grantor's retained interest, the grantee cannot use a principal residence tax exemption for the property until the grantor's death. Also, if the grantee has creditors, a Lady Bird deed may not be the best option. If the grantee's interest in the property is characterized as a remainder, that interest is potentially subject to levy or execution.
If you'd like to learn more about Lady Bird deeds and whether they are the best option to meet your particular needs, we invite you to contact us to schedule a free initial consultation.
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