What wealthy parents need to know about giving real estate to heirs
A local house with a porch in Edgartown on Martha’s Vineyard, Massachusetts, USA.
Wolfgang Kaehler | Lightrocket | Getty Images
A version of this article first appeared in CNBC’s Inside Wealth newsletter with Robert Frank, a weekly guide to the high-net-worth investor and consumer. Sign up to receive future editions, straight to your inbox.
The great wealth transfer is leading to a great real estate transfer, with up to $25 trillion in real estate owned by older generations that could get passed down — and fought over — in their families.
According to Cerulli Associates, $105 trillion is expected to be passed down by baby boomers and older generations by 2048. Real estate, including primary and vacation homes, as well as investment properties, is expected to be a large component. The silent generation and baby boomers own nearly $25 trillion in real estate combined, according to the Federal Reserve.
Yet with property comes conflict. Wealth advisors say handing down real estate is increasingly filled with both financial and emotional pitfalls for families, ranging from taxes and maintenance costs to disputes over ownership and usage. The straightforward solution is just to sell it and divide the proceeds.
“Some people want to retain the house and other children don’t,” said BNY Wealth’s Jere Doyle. “I can tell you, as a practical matter, there’s going to be fights. There’s going to be disagreements. You’re not going to have the perfect situation.”
But lawyers and wealth planners say there are measures families can take to more effectively pass down real estate to minimize taxes, costs and family battles. Here are five secrets to successful real estate inheritances, whether it’s an apartment on Park Avenue, a beach house on the Vineyard or a ranch in Montana.
1. Transfer real estate in your will or through a trust to avoid a major tax bill.
Passing down vacation homes is the most fraught, said Elisa Rizzo of J.P. Morgan Private Bank. Her clients often downsize their primary residences later in life, but families stay attached to their second homes.
“That vacation home, often for our families that are very mobile, becomes the centering place,” said Rizzo, head of family office advisory at JP Morgan. “The vacation homes are where people go, and they make really special memories with one another, whether it’s a ski house up in Vermont or a vacation home on Nantucket.”
Doyle advises against gifting long-held real estate before you die. If your heirs choose to sell the property, they have to pay capital gains taxes on the property’s appreciation since the parents originally bought the property.
“If you give during your lifetime, the kids take your cost basis,” said Doyle, senior estate planning strategist for BNY Wealth. “One of the things that people have to bear in mind is that the senior generation probably didn’t pay an awful lot for the property.”
There are ways to minimize the tax burden, such as using a qualified personal residence trust. However, if you can afford to wait, it is best to leave real estate to your heirs in your will or in a trust at death, according to Doyle. If the heirs later sell the property, they only have to pay capital gains taxes on how much the home has appreciated since they inherited it.
2. Use LLCs and trusts to shield the home from lawsuits.
Rather than having the heirs own the property directly, lawyers recommend placing homes in a limited liability company and setting up a trust for the kids’ benefit that holds interest in the LLC.
These legal maneuvers protect assets in several ways. For instance, if a vacation home is rented and a tenant slips and falls, the heirs are not held personally liable for any damages.
“Your other assets, stocks, bonds, are not subject to any creditors’ claims,” Doyle said.
It also shields heirs from the liabilities of their siblings, according to Dan Griffith, director of wealth strategy at Huntington Private Bank. For instance, if one heir files for bankruptcy, the LLC structure prevents the creditors from putting a lien on the shared home, he said.
You can also save on transfer taxes by gifting interest in an LLC that owns the property rather than putting heirs’ names on the deed, Griffith said. Since these fractional interests are illiquid, parents can claim a discount on the taxable value.
3. Outline who gets to use the home and how.
Parents can put rules in place with an operating agreement for the LLC. Clients can use the document to make sure the home doesn’t end up in the hands of their children’s spouses, which is a common concern, according to Northern Trust’s Laura Mandel.
“Typically families want to retain these properties along the bloodline,” said the chief fiduciary officer.
Parents can restrict an…
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