Real property is often the most complicated trust asset for trustees to manage. Trustees often want to do their best while also pleasing the beneficiaries, who are often their siblings or family members, and still follow the terms of the trust. This four-part series will discuss common scenarios in our trust administrations involving real estate.
To begin this discussion, some background information is required. This is a common scenario in trust administrations.
Harry and Wendy, a married couple living in California, created a revocable trust during their lives as a part of their estate plan. They have three adult children: Susie, Tom, and Michael. When Harry and Wendy die, their trust becomes irrevocable, and it holds the house that the children were raised in, a checking account with $40,000 and a brokerage account with $300,000. They purchased the home for $100,000, and its fair market value is $900,000 as-is and could fetch up to $1,500,000 if they put $300,000 worth of deferred maintenance and upgrades into the property. Before H and W’s death, the county assessor assessed the house at $300,000 for property tax purposes.
Harry and Wendy’s trust names Susie as their successor trustee and states that the trust property will be divided equally between the three children. The trust allows for in-kind distributions, meaning the kids can pick and choose what assets they receive as long as they each receive assets adding up to their 1/3 shares. They don’t have to split each asset in three ways.
The first part of this series will tackle the common issue of one sibling wanting to keep the home as an investment property for the whole family.
Tom wants to keep the house owned by the three of them as an investment property, fix it up with trust money, and rent it out, and he would like to be the property manager.
For this scenario, there are several items that need to be discussed and agreed upon by the beneficiaries. The first discussion point is whether it is a worthwhile investment for all of the beneficiaries. The property is going to be reassessed for property taxes under Prop 19 (see more about property taxes and Prop 19 here: https://absolutetrustcounsel.com/all-about-taxes-with-an-estate-planning-flair-part-iii/). This means that the property taxes will increase from $3,000 per year to somewhere between $9,000 and- $15,000 per year. The property tax increase, coupled with the potential costs to bring the home into compliance with the building code, additional repairs or upgrades needed in order to request fair market rent, and the costs of doing business (permits, licenses, insurance, taxes, etc.) should be scrutinized to see if 1) all the beneficiaries are in agreement to spend the money since you have to spend money to make money and 2) the cost is worth the benefit, i.e., is the profit enough to be worth the hassle of doing the repairs and upgrades and being landlords?
Speaking of agreeing, Susie, Tom, and Michael will now be co-owners of a home and landlords. They have to agree on how to split future costs, duties, and responsibilities. This means that they should have an ownership agreement drawn up that shows how they make decisions, how costs are paid, how they are paid income, or how income and expenses are allocated for tax purposes. This can get very complicated, and families don’t often think about any of this until they are in disagreement and are forced to sell or buy each other out. Additionally, if Tom is going to manage the property, they have to agree on what he will be paid and if they need to worry about payroll taxes, insurance, workers’ compensation, etc. They should also discuss whether they want to own the property as an entity, such as an LLC or corporation, rather than as a partnership in order to protect themselves from personal liability.
Keeping a family home as a rental property is a huge responsibility, and when you throw in multiple owners, it can be a recipe for disaster if it is not done right and with attention to detail.
So, how do Trustees and families solve this type of conflict? The best solution is for the parents, Harry and Wendy, to update their trust during their lifetimes to instruct the trustee on how to manage the house. This should begin with a family meeting about what everyone’s expectations are, and Harry and Wendy can then decide and advise the family to manage their expectations. Maybe the siblings don’t want to be in business together or don’t want to spend cash they would otherwise inherit fixing up a house. They might also need that inheritance quickly to pay for education or medical costs, and it wouldn’t be fair to tie up their whole inheritance in a rental that may or may not be profitable.
If that solution is not achievable, the Trustee has the authority to sell the house. If Tom wants it as an investment property, he can purchase it on the open market, to be fair to his siblings if they cannot all agree on a purchase price.
Come back next month for Part II as we discuss the next common situation of when a sibling wants to take the house as a part of his share and buy out his siblings without having the home reassessed for property taxes.
[AD] The job of a trustee isn’t as easy as one may think. You must give legal notices, retitle assets, file tax returns, understand a legal document, and perform a variety of tasks most people find unfamiliar. As a trustee, if you forget a step or make a mistake, you could be held liable.
Protect yourself, have a plan, and find out the next steps about your specific trust. Get started now by scheduling a 20-minute discovery call with Absolute Trust Counsel. During this introductory call, we will gather information about your trust administration, review our trust administration process with you, and answer any questions you may have. Our goal is to help you get the job done right!
