Estate planning gets even trickier when property is involved
Here’s how to avoid real estate battles between heirs
People don't intend to tear apart their families when they neglect to draw up an estate plan or make a will. Some simply don't get around to it. And others are procrastinating because of the uncertainty around potential tax changes. But when you have a piece of property that's split among multiple siblings without any direction from the deceased, what may have begun as benign neglect can turn malignant.
Disputes over a piece of real estate can tear families apart. Often the damage is irreversible, and the scars can last a lifetime.
It doesn't have to be that way.
Real estate is tricky because it's illiquid; it's also usually the most valuable single asset in an estate. So what happens when the parents pass away, and one child wants to hang on to the house or the family farm but their siblings don't?
There are several straightforward planning decisions the property owner can make now to avoid strife later. Fortunately, these are relatively inexpensive to implement – especially if they reduce lawsuits and emotional pain later.
Parents might consider taking out a life insurance policy. After their deaths, one child could receive the house and the other heirs would share the proceeds of the insurance.
Another option is to create a document stipulating that the child who wishes to keep the house may purchase it from the estate at a discount. Alternatively, the child could live at the house and pay the other siblings rent.
Tax planning can avoid bankruptcy filing
In these cases, having a trusted financial advisor can make all the difference since they can offer insights into a variety of options for property distribution. Their advice on the tax implications of inherited real estate can be particularly valuable, especially if heirs have decided to sell it. Most families don’t realize that the tax bill on capital gains from the sale of real estate can be staggering. I’ve even seen some families resort to bankruptcy due to the tax hit.
In a case where the bequest involves investment properties, advisors might explore a 1031 exchange, which essentially provides a tax-advantage method of trading one property for another.
An outside advisor can be invaluable to this process not only for the expertise in estate planning they will bring, but also because they can help families navigate the emotional aspects of splitting up an estate. Real estate is different from an asset such as cash or stocks. It's likely going to carry sentimental value for all the heirs, and it can't simply be simply distributed evenly among the beneficiaries.
But it takes a plan, and often a financial advisor will need to step in to make that plan a reality.
Bruce Willey, JD, CPA, is the founder of American Tax & Business Planning, LLC. He has been advising individuals and business owners in accounting, tax and wealth-building strategies for more than three decades. To speak with him or another ATBP expert, please reach out here or at https://www.americantbp.com/contact-american-tax-and-business-planning.