A Race to the Courthouse?

December of 2012 was a very busy month for many estate planning attorneys and certified public accountants who deal with trusts and estates. With the Estate Tax / Gift Tax exemption expected to drop from $5,120,000 in 2012 to $1,000,000 in 2013, many clients decided to make gifts of substantial assets in 2012 in order to take advantage of the higher exemptions. The key to this strategy was the timing of the gift. If the gift was “completed” in 2012, they successfully took advantage of the more liberal 2012 rules. If the gift was not “completed” until 2013, they likely created further tax problems. Therefore, the question of when a gift has been legally “completed” is critical.

While clients gifted all types of assets in December of 2012, a very common asset gifted was real property such as homes, commercial buildings, and vacant land. Typically, real property is transferred by a deed that is recorded with the county. A legal principal that many attorneys had to remember from law school is whether the recording of a deed is necessary to “complete” the transfer, or whether signing the deed is sufficient. If recording is necessary, then it would be a “race to the courthouse” to get the deed recorded by the end of 2012. If recording was not necessary, then the deed could be signed and notarized in 2012 but not recorded until 2013 – the pressure would therefore be lessened.

Before the concept of a “deed” was developed, the conveyance of land in England did not depend upon a written instrument. Instead, a method known as a “feoffment” was utilized where the parties to the transaction would meet upon the land with witnesses. The grantor would orally announce the conveyance to the grantee and would hand over a twig or a clump of earth to symbolize the transaction. Subsequently, laws were passed that required a written instrument be utilized in order to convey real property. Although there are other methods used to convey real property, today the most common method for conveying real property is a deed.

The requirements for a valid conveyance of real property by deed are (1) execution of a (2) valid deed, (3) delivery of the deed, and (4) acceptance of the deed. “Execution” simply means that the transferor signs the deed. In order for a deed to be “valid,” it must contain a description of the land and clearly communicate intent to convey the real property between the parties. “Delivery” does not require that the deed be physically transferred to the grantee, but rather it is a question of whether the grantor intended that the deed be presently operative. “Acceptance” is presumed if the conveyance would be beneficial to the grantee and sometimes it is not even necessary that the grantee was even aware of the existence of the deed.

The recording of the deed is not necessary in order to effectively convey real property. California adopted this English principal. In fact, California Civil Code Section 1217 states: “An unrecorded instrument is valid as between the parties thereto and those who have notice thereof.”

The recording system is in place simply to put third parties “on notice” of the current ownership of the property. It is designed to prevent an unscrupulous person from selling property that he or she does not own (such as the Brooklyn Bridge), or selling the same property more than once. In the latter example, there is an exception in California that makes the recording of the deed significant in determining who holds valid title.

For example, let’s assume that Scoundrel executes a valid deed transferring real property to Bing on Day 1. Bing does not record the deed because under the law, recording of the deed is not necessary to complete the transfer. On Day 2, Scoundrel executes a valid deed transferring the same real property to Gwen. Gwen decides to record it. Under California law, as long as Gwen was not aware the previous deed to Bing, Gwen will have valid title. This result reverses the general principal that recording is not necessary to complete a transfer because the reasoning is that all Gwen should be required to do under the law to ensure that Scoundrel is the current owner of the real property is to examine the public records.

This exception to the general rule that recording of a deed is not necessary to convey title is known as a “notice-race” rule. The term “race” is used because it conjures the fictitious image of Bing and Gwen “racing” to the courthouse to record their deeds first. It’s fictitious because if Gwen is actually aware of Bing’s deed, she cannot prevail even if she records her deed first.

The bottom line is that all valid deeds that were signed in 2012 are “completed” 2012 gifts, even if the deeds are not recorded until 2013. In “notice-race” jurisdictions, the one exception might be if the grantor decided to gift the same property to two different grantees and the second grantee recorded the deed first. However, in this context of gifts between family members for estate planning purposes, that would be very unlikely!