Transfer on Death Instrument: Advantages and Disadvantages

The newly enacted Illinois Residential Real Property Transfer on Death Instrument Act authorizes another way to transfer real property, starting on January 1, 2012. PA 97-0555, HB 1153. The transfer on death instrument is a revocable instrument that allows an owner to transfer residential real estate to one or more beneficiaries on the owner's death. The transfer on death instrument gives Illinois residents another choice when trying to avoid probate while transferring ownership of residential real property. Other options for bypassing probate include living trusts, joint tenancies and life estates. This article will examine the advantages and disadvantages of the transfer on death instrument in comparison to living trusts, joint tenancies and life estates. The analysis will offer guidance on which option, based on the needs and circumstances of the owner of real property, will lead to the most beneficial outcome.

Transfer on Death Instrument

The Illinois transfer on death instrument allows an owner of residential real property to designate one or more beneficiaries who will receive interest in the property on the owner's death, bypassing probate. The definition of "residential real property" is defined as "real property improved with not less than one nor more than four residential dwelling units … or condominium units … or a single tract of agriculture real estate consisting of 40 acres or less which is improved with a single family residence."

When making or revoking a transfer on death instrument, the owner must have the same capacity required to make a will. Any person who is 18 years or older and is of "sound mind and memory" has the capacity to make a will. 755 ILCS 5/4-1. The requirements for making a transfer on death instrument are as follows:

  1. The document must contain the "essential elements and formalities of a properly recordable inter vivos deed," although a transfer on death instrument does not require notice, delivery, or consideration to be effective. That means that there must be a grantor, a grantee, a description of the property to be conveyed, language of conveyance, and a signature by the grantor.
  2. The document must be signed by two witnesses.
  3. The document must be notarized.
  4. The document must state that the transfer to the designated beneficiary occur at the owner's death.
  5. The document must be recorded before the owner's death.

The beneficiary has a right to either accept or disclaim the transfer on death instrument. If the beneficiary chooses to accept the transfer on death instrument, the beneficiary must sign and file a "notice of death affidavit and acceptance" after the owner's death. If a notice of death affidavit and acceptance is not filed within two years after the owner's death, then the transfer on death instrument is void and ineffective and the residential real estate will pass to the owner's estate. The act specifies the information needed in the notice of death affidavit and acceptance and provides a sample form.

While the transfer on death instrument must be recorded before the owner's death, the interest in the real estate only transfers on the owner's death. This means that the beneficiary does not have any rights to the real estate while the owner is alive and the beneficiary's creditors cannot place a lien on title to the property. On the other hand, during the owner's life, the owner retains the right to sell or encumber the residential real estate and the owner's creditors can claim an interest in the property, which would transfer to the beneficiary on the owner's death.

Joint owners may also execute a transfer on death instrument and it would not sever a joint tenancy or tenancy by the entirety. If all of the joint owners execute the transfer on death instrument, then it can only be revoked by all of the living joint owners and the last surviving joint owner may revoke the instrument. If less than all of the joint owners execute the transfer on death instrument, then the last surviving joint owner governs the validity of the instrument. If the last joint owner to die did not execute a transfer on death instrument, then any prior joint owner's designation of a beneficiary is ineffective.

The transfer on death instrument is revocable. There are two ways an owner can revoke a transfer on death instrument:

  • with another transfer on death instrument that expressly or by inconsistency revokes the original document; and/or
  • with an instrument of revocation that expressly revokes the original transfer on death instrument.

Similar to the requirements for making the transfer on death instrument, the revocation must be witnessed, notarized and recorded before the owner's death in the public records.

Advantages and Disadvantages of a Transfer on Death Instrument

A transfer on death instrument is less complex and less costly to draft than a living trust. It is also revocable, which gives the owner flexibility to change his or her mind regarding who he or she wants to designate as the beneficiary. Another benefit of the transfer on death instrument is that it allows the owner to retain a present interest in the residential real estate during the owner's life. The beneficiary's creditors cannot burden the property while the owner is alive because interest only transfers on the owner's death.

Alternatively, while the owner is alive, the owner retains the right to sell or encumber the residential real estate. The owner's creditors can claim an interest in the property and liens attached to the property transfer to the beneficiary on the owner's death. Additionally, joint owners can complicate the transfer of real property if not all of the joint owners execute the transfer on death instrument. Generally, the last surviving joint owner dictates whether there will be a beneficiary and who is designated as the beneficiary.

Another disadvantage is that a transfer on death instrument likely cannot avoid estate taxes. Because the instrument is still new in Illinois, no rulings or statements has been made by courts or the legislation. However, states with a similar transfer on death law have announced that a transfer on death of residential real property cannot avoid estate taxes. See below for a discussion of estate taxes and life estates, which may also apply to transfer on death property.

While the transfer on death instrument is intended as a means to bypass probate when transferring an owner's residential real estate, there are obstacles to a probate-free transfer if the designated beneficiary dies before the owner. If the sole designated beneficiary does not survive the owner and is a descendant of the owner, then the residential real estate passes per stirpes to the designated beneficiary's living descendants at the time of the owner's death. However, probate cannot be avoided if the sole designated beneficiary does not survive the owner and is not a descendant of the owner; in this case, the residential real estate passes via the owner's estate. Furthermore, the owner can name more than one beneficiary. If one of the designated beneficiaries does not survive the owner, then the living beneficiaries can take the shares of the deceased beneficiary. If the deceased designated beneficiary is a descendant of the owner, then the deceased beneficiary's living descendants can take the deceased beneficiary's shares per stirpes.

The transfer on death instrument would be most beneficial for small estates, particularly situations where there is one owner and one beneficiary, or between committed partners who are not married or do not have a civil union, or those who do not need the tax benefits of a living trust. For example, a widow might create a transfer on death instrument to transfer her sole asset, a house, to her only child as the beneficiary. This would ensure that the widow retains rights in her house during her lifetime. On her death, the house would transfer to her child while avoiding the delay of probate. A transfer on death instrument can avoid the complexity and expenses of a living trust and the disadvantages of forming a joint tenancy or life estate. These disadvantages will be discussed in the sections below.

Living Trusts

Living trusts are a flexible, private way to manage a person's assets during his life and provides for orderly distribution of the assets after death, while avoiding probate. Living trusts are most beneficial for large estates with many different types of assets to be distributed to multiple beneficiaries. The provisions in a living trust can be adjusted to meet the needs of each specific property owner. The flexibility of the living trust instrument gives the owner great control over the distribution of his property. The living trust document can specify when the beneficiary receives property. For example, the living trust can state that property will be held in trust for the beneficiary until the beneficiary reaches age 25. This condition is effective regardless of whether the owner is alive or dead. On the other hand, a transfer on death instrument only passes residential real estate to the beneficiary on the owner's death.

Another advantage is that the living trust can ensure management of the owner's property during the owner's life as well as after death. If the owner becomes incompetent or disabled, the trustee of the living trust will manage the trust estate on the owner's behalf. On the other hand, a transfer on death instrument does not provide for management of the owner's residential real estate if the owner is alive but unable to manage the estate for himself. If the owner does not have a property power of attorney, the estate will likely be managed by a court-appointed guardian.

A living trust can be structured to avoid estate taxes and prevent creditors of the beneficiary from reaching the assets of the trust. As noted previously, a transfer on death instrument likely cannot avoid estate taxes. Additionally with a transfer on death instrument, after the residential real estate has transferred to the beneficiary on the owner's death, the beneficiary's creditors can reach that residential real estate.

Finally, living trusts can completely bypass probate, even if the beneficiary predeceases the owner. On the other hand, a transfer on death instrument may have to go through the probate process if the sole designated beneficiary predeceases the owner and that deceased beneficiary is not a descendant of the owner.

However, the main disadvantages of a living trust are its complexity and high costs. Because the living trust can be structured to meet the specific needs of a property owner, there are a myriad of ways to prepare the living trust instrument, which could lead to a greater likelihood for ambiguities or mistakes. A lawyer's expertise is is generally necessary to minimize the ambiguities and mistakes that may arise. The process requires careful consideration and analysis, hence the high cost.

Joint Tenancy

A joint tenancy can be created by stating in the deed instrument that the property is held not as tenants in common but with right of survivorship. 765 ILCS 1005/1b. Joint tenancy allows two or more people to share equal ownership of property and have an equal, undivided interest in the property. The right of survivorship provides that if a joint tenant dies, the remainder of the property is transferred to the survivors. This survivorship right is similar to the effect of a transfer on death instrument when the owner dies.

While joint tenancy can avoid probate through right of survivorship, there are many drawbacks to consider. The main disadvantage of a joint tenancy is that one tenant can burden the property independently of the other joint tenants. Because each joint tenant has a present interest and ownership right in the real estate, any creditor of a joint tenant may place a lien on the property. Conversely, a transfer on death instrument does not convey an immediate interest in the beneficiary. Thus, a designated beneficiary's creditors cannot reach the residential real estate until the owner's death.

Decisions regarding joint tenancy property must be made jointly by all of the tenants. This can harm the joint tenants if there is a disagreement regarding how to manage the property. Additionally, a joint tenant can force a partition by conveying or selling his interest in the property to a new owner. This act would break the joint tenancy and the parties would own the property as tenants in common. A distinctive feature of a tenancy in common is that there is no right of survivorship. This would defeat the purpose of a property owner creating a joint tenancy in order to transfer title while avoiding probate.

Note on Tenancy by the Entirety

Tenancy by the entirety is a form of joint tenancy that is only available to a married couple or parties in a civil union. See 765 ILCS 1005/1c. A key advantage of tenancy by the entirety is that one tenant cannot burden the property independently. That is, unlike joint tenancy, creditors of only one tenant cannot place a lien on property held in tenancy by the entirety. Creditors of both tenants can however take the property to satisfy debts owed by both tenants. While tenancy by the entirety can avoid probate, it is inapplicable for owners wishing to transfer property to a beneficiary who is not a spouse or civil union partner.

Life Estates

A life estate gives a person the right to use and enjoy property during that person's life. The owner of the present interest in the life estate property is known as a life tenant. After the life tenant's death, the property reverts to the remainderman, who may be the grantor of the life estate or someone else designated by the grantor. Life estates can be used to avoid probate and ensure that the intended beneficiary receives title to real property. An owner of real estate can transfer title to the property to the intended beneficiary while the owner retains a life estate in the home. The owner then has a present interest in the real estate and the intended beneficiary has a future interest or vested fee simple remainder. When the owner dies, the beneficiary automatically has a fee simple title to the real estate without going through probate. The life estate is easy and inexpensive to create. It requires a deed that creates the life estate and documents to transfer title.

The life tenant has rights to use and enjoy the property as well as the responsibility for the costs of maintenance and taxes on the life estate. A life tenant cannot give a greater interest in the estate than what he owns. Thus, a life tenant cannot give complete and definite ownership to another person because the life tenant's ownership in the property ends at the life tenant's death. Additionally, the life tenant cannot sell the full title to the property without permission of the remainderman. Therefore, the life tenant's limited rights to convey and encumber the life estate means that claims against the life tenant are not liens on the full title to the property. This is distinguished from the transfer on death instrument, where the owner retains all rights to the property and can convey or encumber it during the owner's life, thus affecting the beneficiary's rights without the beneficiary's signature.

Unlike the transfer on death instrument, the life estate is irrevocable. The owner cannot recover the property conveyed to the remainderman unless the remainderman is willing to give it back. Another disadvantage of the life estate is that though the property is conveyed to a remainderman, the property remains in the life tenant's estate for state and federal estate tax purposes. 26 USC § 2036; 20 CFR § 20.2036-1. Thus, neither the life estate nor transfer on death instrument avoids estate taxes. Creation of a life estate may also result in gift tax liability. While a life estate is easy to create and avoids probate, it may be prudent to hire a lawyer to avoid tax liability.

Additionally, it is important to consider the consequences of creating a future interest in a remainderman who may not be alive when the life tenant dies. Complications could arise in determining whose interested has vested. Therefore, a life estate is most beneficial for elderly parents wanting to transfer a house to their child while continuing to live in their home before death. Life estates are also beneficial if the parties involved want to ensure that the property remains in the family by naming remaindermen that are closely related to the owner. However, a life tenant has less ability to convey or mortgage the title, which makes the new transfer on death instrument a more attractive option for accomplishing most of the same goals. Of course, the transfer on death instrument is only available for title to residential land whereas a life estate can be used for title to any type of land.

Conclusion

The Illinois transfer on death instrument is a straightforward and inexpensive means to transfer title to residential real estate directly to a beneficiary without going through the probate process. There are other ways to bypass the probate process, such as living trusts, joint tenancies or life estates. Each form of transferring property, while avoiding probate, offers unique advantages and disadvantages. Deciding which form to use will depend on the specific circumstances and needs of the owner of

Posted on: Wed, 09/21/2011 - 9:23am

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