Ladybird Deeds: The Good, the Not-so-Good, but not the Ugly

Take-Away:  A ladybird deed is an effective and efficient way to avoid probate and also help an individual qualify for, if needed later,  Medicaid benefits.

Background: For the last three decades there has been an increased use of ladybird deeds as part of an estate plan. These deeds are sometimes also called ‘revocable life estate deeds’, or ‘deeds with a reservation of a life estate with a general power of appointment.’ As the alternate names suggest, a ladybird deed is a transfer of real estate by deed, with the grantor retaining both (i) a life estate; and (ii) a lifetime  or testamentary general power of appointment. There are several advantages to a ladybird deed which many individuals find attractive.

Advantages to a Ladybird Deed: The advantages to the use of a ladybird deed include:

• Simplicity: Only a deed is required to transfer title to real estate on the titleholder’s death. Unlike a Will or Trust which can be long and cumbersome, or have stringent execution formalities to follow, all that is required is a deed that is witnessed, notarized and recorded with the Register of Deeds.
• Homestead Property Tax Exemption Preserved: If the real property is the transferor’s principal residence, the life estate will qualify for the Michigan real property homestead exemption to avoid some real property taxes.
• Avoids ‘Uncapping’ the Taxable Value: Because the ‘gift’ over to the remainder holder in the real property is incomplete due to the presence of the grantor’s retained general power of appointment, the ladybird deed should not result in an ‘uncapping’ of the taxable value (but see below as a possible disadvantage.)
• No Taxable Gift: The presence of the retained general power of appointment means that the transfer of the interest to the remainder holder is incomplete. Therefore, none of the grantor’s federal gift tax exemption is used to ‘shelter’ the transfer of the value of the remainder interest from federal gift tax.
• Avoids Remainder Holder’s Creditor Problems: A ladybird deed provides protection against a remainder beneficiary’s creditors. The limited property interest of the remainder holder makes it difficult for creditors to make a claim against the real property that is subject to the ladybird In addition, the life estate holder can always revoke or modify the ladybird deed at any time exercising their retained general power of appointment.
• Avoids Probate: When the life estate holder dies, the remainder holder files the life estate holder’s Death Certificate with the Register of Deeds to perfect title in the real estate in the name of remainder holder. Therefore, the real estate does not pass through probate, thus saving time and expense.
• Basis Adjustment at Death: Because the ladybird deed is a lifetime transfer with a retained life estate, IRC 2036(a)(1) applies. Accordingly, the value of the real estate on the life estate holder’s death is included in the taxable estate of the life estate holder. This permits the income tax basis of the real estate to be adjusted, usually upward, to its date-of-death fair market value. [IRC 1014(a)(1).]This is no different than if the real property had passed under the decedent’s Will or revocable Trust.
• Medicaid Eligibility: When an individual transfers property within five years of filing  to receive Medicaid benefits, if the transfer is for less than fair market value, that ‘divestment’ can bar eligibility to receive Medicaid. Because the grantor of the ladybird deed retains full control of the real estate, the property if a homestead retains its exempt status. The execution of the ladybird deed is not deemed a ‘divestment’ for Medicaid eligibility purposes.
• Avoid Medicaid Estate Recovery: If an individual receives Medicaid benefits while alive, the state is entitled to seek recovery of those benefits from the recipient’s estate at death. [42 U.S.C. 1396p(b).] Michigan’s estate recovery is limited to the recipient’s ‘probate estate.’ Since the Medicaid recipient held a life estate under the ladybird deed, the real estate avoids inclusion in the recipient’s probate estate and  thus it avoids the state’s “Medicaid recovery lien.”

Disadvantages to a Ladybird Deed: There are some drawbacks to the use of a ladybird deed that can cause complications. These drawbacks become more apparent when a ladybird deed is compared to those states that have adopted the Uniform Transfer on Death Deed statute, which 28 states have adopted in some form, but not, however, Michigan.

• Property Interest: The key difference is that under Michigan’s common law ladybird deed, the remainder interest holder actually receives some form of property interest in the real estate, by virtue of their subordinate remainder interest to the grantor’s retained life estate. They hold that interest until either the grantor’s death, or the grantor exercises the retained general power of appointment to remove/revoke the remainder holder’s interest in the real estate.

Statutory Deed: In contrast, the ‘beneficiary-on-death’ statutory deed allows the grantor to name a designated beneficiary who will acquire title to the real estate on the owner’s death. As a result, the designated beneficiary does not acquire any property interest in the real estate under a statutory deed. Restated, the statutory deeds does not vest legal or equitable title in the designated beneficiary until the death of the grantor. As a result, neither the designated beneficiary nor the beneficiary’s creditors can reach the real property until the grantor’s death. With the ladybird deed, the remainder beneficiary’s name is in the title to the real property and thus holds some interest in the property, while under the statutory deed approach, the owner’s name alone appears in the title, while the designated beneficiary’s name appears only in the beneficiary designation.

• Mortgages and Lines-of-Credit: Because the remainder holder does hold some property interest in the real estate under a ladybird deed, it is not uncommon for mortgage lenders to require that the remainder holder waive their rights or in some cases sign the mortgage documentation along with the life estate holder. While the retained general power of appointment held by the life estate holder always gives them the right, at any time, to remove the remainder beneficiary from the title, that right of ‘removal’ will be ignored by lenders if the underlying real estate is to be offered as collateral for a loan. Along the same lines, it is possible that a mortgage lender might treat a ladybird deed entered into after a loan was made and the real estate pledged as collateral security as triggering a ‘due-on-sale/transfer’ clause in the loan documentation, effectively accelerating that outstanding mortgage loan.
• Title Insurance: Like mortgage lenders, some title insurers may require joinder of the remainder beneficiaries under a ladybird deed, or require a release from the remainder holder, prior to issuing a title insurance policy. Is the remainder holder even covered by the title insurance policy?
• Uncapping Exposure: Given Michigan’s ‘swiss-cheese’ like Real Property Tax Act with its uncapping rules and a myriad of exceptions to those rules,  and the even more bizarre and strained interpretations given the Act by the Michigan Tax Commission (always seemingly in search of a surprise ‘uncapping’ of taxable value) there is a concern that a ladybird deed that names a non-family member as its remainder holder will trigger an ‘uncapping’ by the local assessor if a property interest is transferred to a non-family member. Under the federal tax law, a ladybird deed is an incomplete gift and thus not taxable. Under state law, a property interest has been transferred with a ladybird While logic would suggest that since a ladybird deed is an incomplete gift, which can be revoked by the grantor through the exercise of the retained general power of appointment at any time, and therefore, the remainder holder’s property interest should only be illusory, the Michigan Tax Commission is not known for using logic.
• Grantor’s Disability: After a ladybird deed has been recorded, the grantor retains the right to revoke the deed through the exercise of the retained general power of appointment. If the grantor later becomes incompetent, can and will an agent under a durable power of attorney for financial affairs exercise their principal’s retained general power of appointment?  Some durable powers of attorney are silent on the ability of the agent to exercise their principal’s general power of appointment. A conservator’s petition to the probate court to seek authority to exercise the power of appointment might not be well received by the judge. If the ladybird deed is going to be a key feature of an individual’s estate plan, there should be a companion durable power of attorney for financial affairs that gives  direction to the agent as to if, when, and how, the general power of appointment is to be exercised in the event of a later incapacity.
• No Standard Deed: The ladybird deed is a creature of common law. There is no single form for such a deed, and as such, there are multiple variations of what a ladybird deed looks like. Not so with the statutory In addition, since the ladybird deed is most often used by elderly individuals who usually own one major asset, their home, they will find the use of the deed an attractive alternative to a more expensive Will or Trust, and thus their temptation to ‘do-it-myself’ which can lead to mistakes in drafting or execution of the deed, which might make the intended ladybird deed invalid.

Conclusion: Because ladybird deeds are easy to understand, cheap, and simple to implement, they provide a great tool to avoid a major asset passing through probate, and also help to enhance the grantor’s Medicaid eligibility, while also avoiding Michigan’s Medicaid recovery lien. To that end, like the statutory deed, the ladybird deed provides an effective ‘safe harbor’ to achieve those objectives. Yet the property interest given to the remainder holder can present some practical problems for a ladybird deed, not the least of which is a possible uncapping if a non-family member receives the remainder interest in the real estate.

Perhaps it is time for Michigan to adopt the Uniform Transfer on Death Deed statute, which would seemingly go along with its other statutes that contemplate the transfer of wealth on the owner’s death like the existing POD and TOD statutes, and the Transfer of Vehicle Title on Death Bill that is currently before the state’s legislature.