Pocket Deeds: Only Fooling Yourself

Pocket deeds may seem like an easy way to outsmart the system and avoid probate on a piece of real property, but they’re often too good to be true.

Elder Law attorney Robert Anderson’s piece in The Iron Mountain Daily News lays out 4 dangers of pocket deeds and why there are better options to achieve the same result.

Probate is time consuming, costly and affects just about everyone, so it's no surprise there are shortcuts to try and get around it. For instance, when dealing with a client who wants to pass on real estate, some attorneys recommend that the property owner draft a deed giving the property to his children, but instead of registering it immediately, the attorney or other representative will hold it until after the owner dies (hence the “pocket deed”). The deed is recorded after death, allowing the property transfer to sidestep the probate process.

It seems clever. And in most jurisdictions, it’s not technically necessary to record a deed after all. But there are a number of issues that can arise, mostly regarding the requirement that a deed be “delivered” to the new owner before it can be considered valid.

The first pitfall is the most obvious. There’s always the chance that the deed will be lost, destroyed or otherwise forgotten and never disclosed to the beneficiaries. In this case, probate would be required and, since the property would not likely be included in any will (if there is one), the decedent would have very little control over who got it (it would likely pass either through a will’s residuary clause or, in the absence of a will, through intestacy).

Another problem the article addresses is Medicaid. Medicaid eligibility involves some examination of the applicant’s income level and assets. In one highlighted case, an elderly person with a pocket deed chose not to report the property on her Medicaid application (artificially reducing her assets), then, after her death, her child recorded the deed. Since at the time of her application, the transfer was not valid because it was not yet delivered to the child, the woman still technically owned the property. This served as the basis of a Medicaid fraud claim brought against her son.

A third risk, and one that planners have been paying far more attention to lately, is the loss of the increasingly valuable step-up in cost basis that the property would receive had it been transferred by will as opposed to gifted. Though this factor won’t be immediately painful, any future sale of the property could be subject to a large increase in capital gains tax because of the low basis.

Finally, depending on the jurisdiction, there are a number of potential property tax issues that could arise from failure to record. And, the article notes, assessors often take a negative position on property taxes when deeds aren’t recorded.

Ultimately, if a given technique appears too good to be true, it probably is. There are a number of strategies—living trusts or a joint ownership via "life estate deeds" are two mentioned specifically—that, while more costly and time-consuming to set up, can avoid probate while eliminating a great deal of risk. End-arounds like pocket deeds are rarely productive in the end.