Take-Away: Ladybird deeds and retained life estates are a cheap, popular, and albeit informal, ways in which to transfer real estate on death as part of an estate plan. However, there could be a risk to the remainder holder of such real estate, if he or she later finds themselves in a divorce.

Background: For at least the last decade (and more) a popular estate planning technique is the lifetime conveyance of real estate to children or grandchildren where the transferor retains a life estate in the transferred property. When the life estate ends on the transferor’s death, title passes automatically to the designated remainder holders, without the need (or the expense) of probate. All the remainder holder must do is record the life estate holder’s death certificate with the applicable Register of Deeds to perfect their title to the real estate. In addition, since the deed is with a retained interest, the full fair market value of the real estate is included in the life estate holder’s taxable estate for federal estate tax purposes. [IRC 2036(a)(1).] That means that the income tax basis in the real estate will be adjusted to its fair market value as of the date of the life estate holder’s death. [IRC 1014.] Finally, even though the conveyance is made during life, residential real estate will continue to qualify for the Michigan homestead real property tax exemption since the retained life estate qualifies for the homestead exemption, such that the deed to a principal residence with the retained life estate will not result in an uncapping of the real estate’s taxable value.

Ladybird (or Mary Carter) Deeds: A ladybird deed, also lesser known as a Mary Carter Deed (I am clueless who Mary Carter is or was) is a refinement of the lifetime deed with the retained life estate just described. With a ladybird deed, in the body of the deed,  the transferor also retains, besides the life estate interest, a general power of appointment over the real property, including the ability to convey the real property to themselves or to third parties. This retained general power of appointment in the body of the ladybird deed accomplishes two purposes: (i) the existence of the general power of appointment results in no taxable lifetime gift, i.e. the transfer of the remainder interest is incomplete since the transferor, using the retained power of appointment, can ‘undo’ the transfer of the remainder interest; and (ii) most transferors want to retain control over the transferred property, including the ability to mortgage or sell the property without the need to obtain the consent of the remainder holder, and without the need to have to share any of the resulting sales proceeds with the remainder holder. In short, while the transfer-on-death beneficiary designations have become a popular alternative for trusts for the transfer of marketable securities on the owner’s death as a way to avoid probate, a ladybird deed functions in much the same way to avoid probate without the need for a trust, while retaining full control over the asset until the owner’s death, along with the possibility of an income tax basis step-up on the owner’s death, resulting in a new income tax basis for the remainder-holder, now owner, of the real property.

If the remainder holder under a ladybird deed encounters future creditor problems, the creditor arguably will not bother looking to the remainder interest in order to satisfy their claims. This for two reasons: (i) the life estate holder is entitled to be compensated for their interest if the real  property is sold, so the creditor would have to incur a lot of expense to seek a forced sale of the real estate without any expectation of receiving all of the net sales proceeds from that forced sale; and (ii) more than likely, the life estate and general power of appointment holder will simply exercise their power of appointment and eliminate the remainder holder’s entire interest in the real property, so there will nothing for the creditor (or a divorce court) to attach.

A recent court decision from the Michigan Court of Appeals seems to put a damper on the popular use of a lifetime transfer with a retained life, although the court decision does not indicate if deed in question was a ladybird deed.

Court Decision:  Bouty v Bouty, Michigan Court of Appeals No. 349568 (September 17, 2020)

Facts: Paula and Richard were married for 18 years. Each brought real estate into the marriage. Over their marriage the premarital real estate was sold and reinvested in other real estate owned jointly by both of them. Much of the court decision tracked when their respective real estate interests were sold and reinvested. Suffice it to say, that the divorce judge decided that due to the length of the marriage he was not going to spend much time and energy trying to trace the origins of the funds used to purchase jointly owned real estate. In short, all the real estate purchased during the marriage was treated as marital.

Richard’s parents owned 40 acres in the UP. In 2003 Richard’s parents gave the 40 acres to Richard and Paula jointly, by quitclaim deed, reserving a life estate to themselves. There is no mention in the court’s decision of a retained general power of appointment by Richard’s parents, so presumably this was not a ladybird deed. This property had an unfinished cabin, which was later renovated during the marriage with marital funds. Richard and Paul also harvested about $30,000 of timber off this UP acreage. They also paid the real property taxes. During the marriage, Richard’s father died, but his mother was living at the time of the divorce. At the time of divorce trial the State Equalized Value for the UP real estate was $78,000.

Divorce Court: The divorce judge divided all of the marital estate 50%-50% between Paula and Richard. The judge refused to go back 18 years to try to trace who brought what into the marriage, finding that the commingling of their premarital property with marital property was sufficient for those premarital assets to lose their separate property character. Paula was awarded their marital home, and another parcel of land that they had acquired, and she was ordered to pay Richard $10,000. Richard was awarded two other parcels that had been purchased during the marriage and the $78,000 UP acreage and cabin. These asset allocations resulted in a 50-50 division of all assets.

Dispute: Richard argued that the parties’ remainder interest in the UP real estate, subject to Richard’s mother’s retained life estate, should have been valued at $0.00 by the divorce judge for purposes of the divorce’s property division because remainder interest was not a present interest in the UP real estate. Richard also seemed to imply in his appeal that because the source of the gift was his parents, that only the improvements Richard and Paula made to the UP cabin should have been included in the marital estate for purposes of the property division. That argument was ignored by the divorce judge. Richard appealed the decision of the divorce court.

Appellate Court: The Court of Appeals rejected Richard’s arguments and upheld the 50-50 division of all assets of the marriage, including the UP cabin.

  • The lifetime gift of the UP real property to Richard and Paula was a gift to them both, such that it was not Richard’s separate property, despite the source being his parents.
  • With regard to the value used by the divorce judge for the UP real property, it’s State Equalized Value (SEV) of $78,000, apparently Richard offered no evidence to support why there should have been a $0.00 value assigned to the remainder interest. Nor did the Court of Appeals address the fact that SEV is 50% of the real estate’s presumed fair market value. All other parcels of real estate in the division of property used fair market values.
  • Apparently Richard did not even attempt to provide any evidence of the value of his mother’s retained life estate interest in the UP real property: “[Richard] offers no legal authority to support his contention that …another lower value for ‘Richard’s interest in the UP property….Further [Richard] has not provided any evidence that his mother’s life estate substantially decreased the value of his interest in the property…No evidence indicates that the life estate substantially diminished the value of the property.”
  • The Court also mentioned in passing that Richard’s mother did not reside on the property and she “rarely visited it….The record reflects that the parties made improvements, harvested lumber, and paid the property taxes, all indicia of present ownership and control over the property.”

It is not clear the relevance of this last judicial observation, since Richard’s mother clearly owned a legal life estate in the real property. While Richard and Paula harvested timber and received $30,000, they also paid the real property taxes (perhaps using the timber proceeds.) More to the point, unlike Paula who was awarded the fee interest in parcels enabling her to control and sell the parcels without restraint,, Richard could not sell the UP acreage without his mother’s consent, and even if the UP real property was sold with the mother’s consent, the resulting sales proceeds would have to be shared between Richard and his mother, the life estate holder.

Random Comments:

  • Presumably Richard’s loss was attributable to his attorney who did not seek to place a value the mother’s life estate interest in the UP real property. The Court’s decision does not indicate her age, but presumably the  lawyer, or the judge, could have easily inquired about her age and then accessed the IRS’ life estate tables to identify the mother’s actuarial interest in the UP parcel.
  • It is more than a little troublesome that the Court conveniently ignored the mother’s retained life estate in the UP real property. Just because Richard and Paula paid the real property taxes does not lessen or negate the mother’s life estate interest in the real property. And as previously noted, perhaps there was an understanding that if Richard and Paula were permitted to timber the property and sell that lumber, then they should use the sales proceeds to pay the real property taxes as opposed to Richard’s mother.
  • Paula was free to sell the parcels that she was awarded in the divorce. Richard could not sell the UP real property awarded to him without his mother’s consent. While it is understandable that the divorce judge would not leave Richard’s mother owning real estate with her former daughter-in-law, there was no effort by the judge to apply any discount to the UP real property value awarded to Richard in recognition of the fact that, unlike Paula, Richard was not free to sell the UP real estate, unless there was some discount intended by using the parcel’s SEV and not its fair market value.
  • There is no mention if Richard’s parents retained a general power of appointment over the real property, in effect a ladybird deed. If a ladybird deed had been given to Richard and Paula, it is questionable if that would have made a difference to the divorce judge, or the Court of Appeals. Both courts seemed fixated on Richard and Paula improving the cabin on the UP acreage, their decision to timber the property, their retention of the timber proceeds, their continued payment of the property taxes, and the fact that Richard’s mother (a widow) failed to visit the UP cabin. The fact that a general power of appointment could completely eliminate whatever interests that were given to Richard and Paula, would not have bothered either court since the clear inference from their decisions is that Richard was in control of the property, regardless of how title was held, or the legal rights of each property interest holder in the acreage.
  • Or, maybe the divorce judge and the Court of Appeals thought that they were actually doing Richard a favor if, in fact, the parcel with a SEV of $78,000 was awarded to him, as SEV is supposed to be 50% of the fair market value of real estate in Michigan, so that the value used for the acreage in fashioning a 50-50% division of wealth with Paula was undervalued by $78,000.

Conclusion: Lifetime transfers of real estate to children and grandchildren with retained life estates are a popular form of estate planning. The enhanced life estate coupled with a general power of appointment, the so-called ladybird deed, is just a more rarified version of the life estate technique. While generally the creditors of the remainder holder have virtually no rights to access the real estate until the life estate holder’s death, apparently when it comes to divorce, the former spouse (who is in effect a creditor) may have more rights than the conventional creditor who tries to enforce his or her judgment against a remainder interest.