The Pitfalls of Quit Claim Deeds

Posted by on Jul 15, 2015 in Memos | 0 comments

1. What Does a Quit Claim Deed Convey?

A Quit Claim Deed conveys, without warranty, all of the Grantor’s right, title and interest in the described property (RCW 64.04.050). In short, it conveys whatever interest the Grantor held, which could be no interest at all. For example, if the estate of a deceased individual holds title to the property and the grantor listed on the Quit Claim Deed is the executor of the estate (and not the estate itself), then the grantee listed on the Quit Claim Deed may not have an interest in the property post-Closing, despite the fact that a deed was properly recorded.

2. Due on Sale Clause.

Loan agreements usually contain a provision commonly called the “Due on Sale Clause”. A typical Due on Sale Clause reads: “Grantor shall not, without the prior written consent of beneficiary, which may be granted or denied at the sole discretion of beneficiary, sell, transfer or otherwise convey the property or any interest therein, cause or permit any change in the entity, ownership or control of grantor (other than transfers of limited partnership interests) or agree to do any of the foregoing without first repaying the note in full.” In short, lenders generally will not permit borrowers to sell or transfer the property during the term of the loan without first paying off the loan balance unless the lender has expressly agreed to the transfer.

A common example of this in the commercial loan context is a situation where a limited liability company owns the property and one of the majority members of the LLC assigns his/her interest in the LLC to a third party during the term of the loan. A lender can, if there is a due on sale clause in the loan agreement, accelerate the note based on the transfer of majority interest in the LLC and the entire loan balance will be immediately due and payable. Generally, borrowers cannot afford to pay the entire loan balance upon demand and will thus be considered in default and subject to foreclosure proceedings.
An example of this in the residential context is a situation where the seller has financed the sale to a buyer that intends to flip the property. Flippers will be likely to accept a quit claim deed as part of the transaction because they are just going to turn around and sell the property to a third party. If the seller cannot pay the loan off in full prior to giving the quit claim deed, the due on sale clause will be triggered by the execution of that quit claim deed and the debt accelerated.

It is important to keep in mind that title companies often won’t close in the event there is a due on sale clause and the underlying loan is not being paid off at Closing.

3. Homestead Right.

A homestead consists of real or personal property that the owner uses as a residence (RCW 6.13.010). If the owner is married, the homestead may consist of either community property or property separately owned by either spouse. The homestead of a spouse cannot be conveyed or encumbered unless the instrument by which it is conveyed or encumbered is executed and acknowledged by both spouses.

Where a buyer is a married person, it is necessary that the buyer’s spouse execute a Quit Claim Deed to establish the property as the buyer’s separate estate before the title company can insure the buyer as “married as a separate estate.” If one married buyer has good credit and the other does not, and both are living on the property, the lender may require the spouse with poor credit to give up his or her automatic homestead by executing a Quit Claim Deed to the other as a condition of granting the loan. A better remedy would be for only the spouse with good credit to be on the Note with both spouses on title.

Where buyers purchase property jointly and get married later, it is a good idea for the newlyweds to execute a quit claim deed from them as joint tenants to them as a married couple if they intend for the property to be considered community property.

4. Excise Tax.

Transfers by Quit Claim Deed not involving a mere change in identity are generally subject to excise tax.

For example, Andy quit claims his property to Amazing Andy, LLC, a company owned 100% by Andy. The lender waives the due on sale clause and Andy simply continues to make monthly payments on the underlying loan. No excise tax will be due because this is a mere change of identity. Andy owned 100% before the transfer and 100% after the transfer.

However, if Andy quit claims his property to Amazing Joe and Andy, LLC, a company owned 50% by Andy and 50% by Joe, the transfer will be subject to excise tax because Andy’s proportionate interest in the new entity is not the same as it was individually..

Excise tax will also apply to transfers of real property when the grantee relieves the grantor of underlying debt or makes payments on the grantor’s debt. For example, Fred transfers real property to his former spouse Jean after their divorce and Jean assumes the underlying loan that was originally taken out by Fred and Jean. This transaction will be subject to excise tax because Jean is relieving Fred of liability for the underlying debt. However, if the transfer had been made incident to Fred and Jean’s divorce, no excise tax would be due.

5. Gift and Estate Tax.

When using a quit claim deed to transfer real property by gift that exceeds the annual gift tax exclusion, the transferor should meet with an estate planner first to assure the transfer is not going to subject the transferor to gift tax. There may be better ways to transfer the property (e.g. trust, joint tenants with right of survivorship or community property agreement). Also, if property is inherited, it is inherited with a stepped up basis, which is not the case with property conveyed via Quit Claim Deed.

6. Quit Claim Deed as Legal Description.

Do not use Quit Claim Deeds as a basis for legal descriptions in your Purchase and Sale Agreement. Obtain a preliminary title report from the title company and use that legal description (or use the last Statutory Warranty Deed).

An example problem would be a situation where the seller has granted his neighbor an easement. If the buyer looks only to the legal description in the preceding quit claim deed, that legal description will not include that easement. A purchase and sale agreement can be voidable where the incorporated legal description is incorrect.

7. Title Insurance.

It is important to keep in mind that a grantee will not have the benefit of grantor’s title insurance where the property is transferred via quit claim deed. This can be a problem, for example, where grantor, an individual, conveys the property to his wholly owned LLC and does not obtain title insurance to cover this transfer.

The following articles are published for informational purposes and not for the purposes of providing legal advice. Please contact Galvin Realty Law Group at 425.248.2163 for a consultation about your specific needs and circumstances.