Pocket Deeds Are Horrible Planning Instruments

I recently discussed with an estate planner the advisability of using a “pocket deed” to fund a revocable trust.  A pocket deed is a deed that is signed during a person’s life, but "pocketed," that is, not recorded, until after the person dies. Pocket deeds were traditionally used to transfer proper to heirs, but apparently in a more modern approach, it is now sometimes used to transfer property to a trust.  

This technique is usually intended to accomplish two goals:

1. Control – Unrecorded deeds allow the property owner to retain control of the property during his or her lifetime. Since the unrecorded deed is not a matter of public record, the owner remains the record owner of the property.  If the deed stays in the owner's possession )a bid assumption), the owner can destroy the deed if the owner changes his or her mind.
2. Probate – The recording of the deed after the owner's death is usually intended to avoid probate.  If it works (a big assumption), the transfer is treated as being effective when the deed was signed and the property won’t be included in the owner's probate estate.

The biggest objection I have to the modern approach is that it fails to appreciate the advantages of the trust.  In fact, advising a person not to record the deed  suggests that there is some disadvantage to transferring the property to the trust. If the trust is a revocable trust, and you are the trustee, you control the property before and after the transfer.  Since the purpose of the trust is to avoid probate, and transferring the property during your life accomplishes that, why not record the deed?

Pocket Deeds Frustrate Good Planning

Regardless, unrecorded pocket deeds are just a bad idea.  They are inconsistent with the fundamental bases of good planning, which assumes the worst, and on that basis implements a plan before the worst happens to derail the plan.  Worst cases include house fires, lost documents, improperly executed or authenticated documents, scrivener (drafting) errors, and the like. Implementing your plan today means that you will solve and resolve these problems.  Pocketing a deed for recording after your death means that these risks may frustrate your plan.  

Consider the following examples:

• A deed is prepared based upon the prior deed.  The County Engineer subsequently changes property description rules, and refuses to accept for recording property descriptions using historic references.  Years later the owner dies, leaving a signed deed that is not recordable given the subsequent changes.  The property must be probated. If the deed had been recorded when prepared, it would have been owned by the trust at the owner's death, and there would be no probate.  

• The result in the previous situation would be the same if there was an error in the title owner's name, or if the notary forgot to affix a seal, or the signature of the owner was defective, or the property description was defective.  If the deed is presented for recording and rejected by either the County Engineer or County Treasurer while the owner is alive, the owner simply corrects the deed and submits the corrected deed for recording.  If the deed is rejected after the owner has died, there is no one but the executor of the owner's estate that has authority to fix, correct, or amend the deed.  

• A deed is prepared and pocketed by placing the deed in a drawer.  After the owner's death, the family cannot find the deed, or inadvertently disposes of it when cleaning the drawer of other miscellaneous unnecessary paperwork.  Perhaps the person who finds the deed destroys it intentionally, in order to create mischief or opportunity (read on for an example how this might create opportunity).  A lost or destroyed pocket deed is unable to serve any purpose. The property must be probated. 

• A deed is prepared transferring several properties, each to a different child.  The deeds are placed in the family's home safe.  Several years later, one child finds the deeds while retrieving other paperwork from the safe.  He removes the deed transferring the property to himself and records it.  At a minimum the owner no longer controls the property.  More, the owner suffers the risk of loss realized by the child.  If the child declares bankruptcy, for example, the property may be lost to satisfy creditors.     

The foregoing examples simply describe how use of a pocket deed can result in the frustration of your estate plan.   But, that isn't the worst of the pocket deed story; pocket deeds can have significant adverse consequences.  The last example demonstrates how conveying property can create risks.  By the way, none of the examples are problems for an owner who simply conveys his or her real property to his or her trust.

Unrecorded Deeds Can Create a Cloud on Title

Under the laws of most jurisdictions, a deed is not effective until it has been properly signed and delivered.  The delivery requirement is important. Just signing the deed is not enough to complete the transfer.  Delivery of the property is presumed if the deed is publicly recorded.

In ordinary real estate transfers, the deed is delivered and recorded at the time of the conveyance.  But with pocket deeds, the deed is not recorded. There is no proof of delivery during the life of the owner.  This raises a number of questions.  Was the deed delivered to the transferee at all? Can delivery be proved? If delivery was not made, is the failure evidence that the owner changed his or her mind?  If the property is not delivered before the death of the owner, the transfer may be void or voidable.  If the transfer was a gift, meaning that no consideration changed hands, the transfer is not legally enforceable by the transferee.

Questions like these can create a cloud on title, meaning that title insurers will not write a policy on the property without some legal action to clear the title. The transferee would have every incentive to claim that the deed was delivered before the owner died, and the owner is not able to say otherwise. In these circumstances, title companies may be reluctant to simply accept the transferee’s word that the deed was properly delivered prior to the owner's death.  This is especially likely if the deed has remained in pocket (unrecorded) for years before the owner's death.

If the deed recording occurs shortly after execution of the deed, a title company will simply presume that there was valid delivery. But a conservative title company may require a declaratory action to quiet title before it will issue a policy on the property.  An action to quiet title will convert statements regarding delivery to legal testimony in a legal proceeding, after publication and notice to anyone who may claim otherwise. A title company can then be sure that there aren’t any competing claims to the property.

If a title company will not write a policy on the property without a declaratory action, the title to the property is unmarketable. The trustee or new owner will be unable to sell, mortgage, or otherwise deal with the property until the title issue is resolved.  The legal fees for bringing an action to quiet title are usually more expensive and time consuming than proper planning on the front end, and may result additionally in probate.

Unrecorded Deeds Can Give Creditors a Lien on the Property

An unrecorded deed does not put third party creditors on notice that the property has been transferred. This means that the transferor’s creditors (including creditors of his or her estate) may put a lien on the property. This leaves the transferee open to a claim by the transferor’s creditors. If that happens, the transferee would need a legal action to deal with the lien.

Unrecorded Deeds Can Create Tax Issues

Assuming that the owner does not have an estate that is taxable for Federal Estate Tax purposes (i.e., assuming the owner’s estate is worth less than $5.25 million under current law), it is usually better from a tax perspective for the owner to hold onto the property until death. This will give the new owner a full stepped-up basis in the real estate, effectively erasing any appreciation that accrued while the owner was alive. This can result in a significant income tax savings upon sale of the property. This tax planning opportunity is forfeited when a pocket deed is signed during the owner's lifetime.

Property gifted during the owner's life does not receive a step-up in basis.  The transferee would be forced to pay capital gains taxes on the sale of the property using the owner's original basis to determine the taxable gain.

In addition, the transferor is required to file a federal gift tax return (Form 709) for any transfer of property that exceeds the annual exclusion amount (currently $14,000). Since most real estate is worth more than $14,000, the transferor is usually required to file this return when the pocket deed is actually signed. The hassle and expense of filing the Form 709 can be avoided by holding the property until death.

The proponents of the modern version will correctly note that none of those opportunities apply when the property is transferred to a revocable trust.  But, the real nature of the transfer is nonetheless concealed until after the owner's death.  What if a taxing authority argued that the concealment suggested fraud (concealment is an indicia of fraud), and suggested the property was also actually conveyed to the heirs by an alternate pocket deed, which deed was destroyed upon the owner's death.  In this instance the parties conspire to structure a transaction so that it can be characterized in the most favorable way possible after the occurrence of one of several possible events.  In this way, the parties can "have their cake and eat it too."  This can result in the transfer being characterized so as to create a taxable event, and corresponding tax consequence, prior to death.  In other words, what would not have been taxable, can be made taxable by constructing the transaction is a suspicious way.

This danger is precisely why an Ohio senior should never prepare a pocket deed conveying the  home to a child.  The senior will likely claim a homestead exemption reducing the property taxes.  The homestead exemption is not available to the child, especially if the child is not living in the home.  When the the pocket deed is recorded after death, the child will be responsible for repaying the homestead exemption, since the senior was not entitle to the exemption after conveying the property to his or her child, together with interest and penalties for the unpaid taxes.      

Unrecorded Deeds May Invite Legal Challenge

Unrecorded deeds will not necessarily  avoid probate.  As explained above, anything that happens that prevents recording of the deed will necessitate probate of the property.  In addition, a pocket deed may create the opportunity for legal challenge or contest.

I once represented a child that was disinherited by his father's trust.  Of course, upon reviewing the trust, I advised my client that normally there would be little opportunity to contest the trust, and suggested he resign himself to the fact that the trust would be administered according to his father's wishes.  This was particularly unfortunate under the circumstances, because, although the son was once estranged from his father, the father and son had in the intervening years reconciled, and were for several year's before the death of the father on good terms.

Shortly after the father's death, a sibling shared the harrowing work the siblings were forced to perform in days before and after the father's death.  Apparently the deed was just one of many assets that were left out of the trust, until the father fell unexpectedly ill.  The new information breathed life into the son's claim under the trust.  Was it possible that the father has refused to fund the trust given reservations regarding the disinheritance?  If the trust was not an expression of the father's wishes through mistake or change in circumstances, the son would have a viable claim.  Although the matter could easily have been resolved in an expensive court action, it was resolved by settlement.  The settlement, regardless of the circumstances compromised the father's wishes; the son was neither disinherited nor treated the same as his siblings.  It is unlikely that is how the father intended his estate to be resolved.

A Last Will and Testament is more susceptible to challenge than is a trust.  If it is determined that the property is not owned by the trust, and the Will is successfully challenged, the distribution of the estate can be altered from what the owner intended.  If the probate estate is distributed intestate, i.e., without a Will, the estate is distributed according to the heirs at law.  Who the beneficiaries of the trust are is irrelevant to property being probated where there is no Will pouring the estate over into the trust.

In Ohio, perhaps the most famous case arising from a  contest to a deed recorded after death is the case Schueler v. Lynam, 80 Ohio App. 325, 75 N.E.2d 464 (App. 2 Dist. 1947). In that case, the court held that the pocket deed was null and void, in part because partys of the deed required completion after the death of the owner. 

But other states, too, have invalidated pocket deeds as perpetuating fraud. 

Unrecorded Deeds Surrender Intended Benefits of a Trust

Among the possible intended benefits of a trust are protection of the assets from court-appointed guardianship, protection from certain creditors after death, seamless management of the assets during periods of unavailability, incompetency, or incapacity.  These, and many other benefits of trust management are lost when assets are retained in the owner's individual name.  Quite simply, pocket deeds surrender any of the lifetime planning benefits of a trust.  Usually, this means that either the individual was not properly apprised of the benefits of trust planning, or if being directed by a professional representative (agent, financial planner, or attorney), the representative is unaware of the benefits, or is seeking to obtain some other objective.

Because pockets deeds don't always work, almost always take risks that could be avoided by simply implementing a plan, and have unintended consequences, like most attorneys, I do not recommend their use.  

Finally, if you  find an article written by an attorney concluding that pocket deeds are recommended and advisable, please send it to me.  If you are interested, there are many suggesting that pocket deeds should be avoided.  For example, go here, here, here, here, and/or here.