Author Topic: Feedback on inheriting real estate investments  (Read 639 times)

jeromedawg

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Feedback on inheriting real estate investments
« on: November 30, 2017, 01:29:44 AM »
Hey guys,

My dad just threw an unexpected curveball at my two older brothers and I, saying he wants to reduce his and my mom's tax liability/burden by unloading one of his properties (a 1 bed condo/apartment unit on the lower level... although every unit I've looked up on Zillow/Trulia/Redfin/etc seems to indicate that these are all 2 bed units... not sure how they're coming up with that unless they're considering the living/dining area to be the "second bedroom") which is local in the town my parents and one of my brothers lives in up in the Bay Area. It's a 15min drive away so super close to both my parents and one brother. The unit is fully paid off and has appreciated quite a bit I'm sure. I don't know what they paid for it but it's probably worth at least $450k now. They've probably flat-out owned it since at least the 90s, if I had to guess. By "unloading" he means transferring (and presumably gifting) title to my brothers and I so all our names are on the deed. From there, we could decide what we want to do and either continue renting or sell.

Currently, he told us he's renting it out for only $1200 a month. HOA dues are $375 and property tax is encroaching $1700 a year. So the profit margin is low already from what I've gleaned. Fair market rents in that area are maybe $2k based on just looking around online. And the city they're in is rent-controlled to where you can't raise rents for over 5% without getting mandatory approval.

So far one brother has expressed interest in just taking over the property and continuing renting it out. I mentioned raising rent but he was reverting back to "the current tenant is good and pays rent. Don't screw it up" - I then reasoned with him on the basis that if every other neighbor is paying $2k~ in rent and this tenant is the only one paying $1200, it's likely there's quite a lot of headroom for rent increases before they would ever consider moving out. And if we abide by the 5% rent increase rule, we should slowly be able to increase rents in accordance with the city while not pissing the tenant off so much that they'd want to move out. The other option of course is to evict the tenant and bring in a new one and renting according to current fair market rent.  My parents, I think, just wanted a mostly trouble/hassle free rental and aren't landlord types of people (they often accept CASH as a form of payment...ugh). I don't know if they've ever raised rent on any of their tenants and like to think they're doing people favors by giving them a huge discount... I guess it's worked out OK for them? From their perspective, it seems they don't care about this form of income based on how much money they've accumulated and saved over the years. Ironically, it seems real estate is a 'minor' asset for them based on all the discussions I've had with them.

My dad was saying we should just sell the place once it's under our names and reinvest the money in some other property... not quite sure how that would work to our advantage in the Bay Area, considering how crazy housing prices are. Plus we'd get hit with additional taxes wouldn't we? My brothers both aren't investor types (AFAIK) so reinvesting the money out of state likely wouldn't be a possibility for them. If anything, they would likely want to cash out their shares and take the money.

Given this situation, I was looking for feedback on what you guys would do or if there's something that's a flat-out given/no-brainer (like "Yes, keep it, raise rent and keep renting it...) based on what I've shared so far. Or if any of you have been in this type of situation, what you ended up doing and if you'd do anything differently.
« Last Edit: November 30, 2017, 01:35:10 AM by jeromedawg »

nereo

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Re: Feedback on inheriting real estate investments
« Reply #1 on: November 30, 2017, 06:44:09 AM »
First of all, when evaluating "rent vs. sell" it is immaterial how much your parents might have paid for it.  What matters is what it is worth (i.e. what you could sell it for) now.

If you could truly get $450k for the property then you are losing your shirt renting it out for $1,200, particularly when adding $375/mo HOA fees. 
Rule of thumb: Great rentals are 2% of the total sale price and decent rentals are 1% of the sale price.  Doing the math, that's a minimum of $4500 you should be charging in rent each month.  At your current $1200/mo you are getting just 0.26% of the sale price.  If you follow another guideline, that 50% of your rent will be absorbed by taxes, maintenance and vacancies, that $1200 turns into $600 'profit' - and it would tkae you 72 years of rent to recoup the current cost of the house.  Not good!  In reality your situation is even worse, as the HOA fees are high and taxes (together they eat up over $500 in rent every month.  That's before factoring maintenance and vacancies.  Maintenance is roughly 1%/yr the value of the property, so -$375/mo.  Over the long term most landlords factor in either 1 or 2 months of vacancy per year (some years it will be 0, others i might be 2 or 3).  Going on the low side that's another $120/mo. 
The final "rough estimate" numbers look like this:  $1200/rent - $375 HOA - $141 taxes - $375 maintenance - $120 vacancy = $189.  Divided between three brothers and your profit is around $63/mo.

In sum:  Selling this is a no-brainer.  I only question why your dad didn't do it sooner.
Tax implications of selling will involve a lot more information, and frankly I'm not an expert on what happens when a property is gifted to multiple people.


Your dad is suggesting that you cash out the house and buy a better rental property.  Good insofar that he is ok with you guys selling.  But do you actually *want* to be a landlord?  It can be lucrative, but only if you are willing to put some time and effort into it to learn the fundamentals and keep on top of issues.  Going forward though look for properties with much better ratios.  Duplexes/triplexes are popular for a reason, as they can be purchased much more cheaply and each unit ("door") can be rented for 70-80% of what a bedroom in a single-family home goes for.  Check out www.biggerpockets.com for a lot more information on being a landlord.  TONS of info there.

Hope that makes some sense.  Post back with questions/updates.
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hoping2retire35

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Re: Feedback on inheriting real estate investments
« Reply #2 on: November 30, 2017, 07:44:26 AM »
I would be a great tenant too if someone let me live somewhere for free...

Car Jack

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Re: Feedback on inheriting real estate investments
« Reply #3 on: November 30, 2017, 07:57:15 AM »
Not to be Captain Obvious, but why doesn't your dad just sell the place.  Easier on everyone.  If he then wants to gift you guys at $14k level each a year, then, there ya go.  Seems much simpler to me.

Another Reader

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Re: Feedback on inheriting real estate investments
« Reply #4 on: November 30, 2017, 08:15:11 AM »
About the only positive of this idea is you can keep the Prop 13 property tax basis because it's a parent to child transfer.  That's only helpful if you all agree to keep your shares and it counts against the total value that can be excluded from revaluation in parent to child transfers.  If you sell, the benefit is lost but the value still counts against the limit.

If the property is transferred by gift, a gift tax return will have to be filed.  The value of the transferred property will count in the estate tax calculation, if their net worth is high enough to meet the minimum.  You will retain your parents' basis in the property.  If you sell, you will owe the entire capital gains tax on their depreciated basis.  If they have owned this property for a long time, that's going to be a significant percentage of what you net on the sale.

If your parents want to sell, they should do so and consider the capital gains tax as a reduction to your inheritance.  If the property passes to the kids at the second of their deaths, you should get a stepped up basis and have no capital gain. 

The bigger issue here is tax and estate planning.  At the very least, their assets should be held in a revocable living trust, so you avoid probate.  To set this up properly, they need to engage a good estate attorney.  In the Bay Area, that is not going to be cheap.  However, the savings from avoiding probate and transferring assets tax efficiently make this expenditure necessary.  It's hard to convince older people to part with a lot of hard earned dollars to do this, but it's your and your brothers' job to convince them to do this.

hoping2retire35

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Re: Feedback on inheriting real estate investments
« Reply #5 on: November 30, 2017, 08:48:02 AM »
About the only positive of this idea is you can keep the Prop 13 property tax basis because it's a parent to child transfer.  That's only helpful if you all agree to keep your shares and it counts against the total value that can be excluded from revaluation in parent to child transfers.  If you sell, the benefit is lost but the value still counts against the limit.

If the property is transferred by gift, a gift tax return will have to be filed.  The value of the transferred property will count in the estate tax calculation, if their net worth is high enough to meet the minimum.  You will retain your parents' basis in the property.  If you sell, you will owe the entire capital gains tax on their depreciated basis.  If they have owned this property for a long time, that's going to be a significant percentage of what you net on the sale.

If your parents want to sell, they should do so and consider the capital gains tax as a reduction to your inheritance.  If the property passes to the kids at the second of their deaths, you should get a stepped up basis and have no capital gain. 

The bigger issue here is tax and estate planning.  At the very least, their assets should be held in a revocable living trust, so you avoid probate.  To set this up properly, they need to engage a good estate attorney.  In the Bay Area, that is not going to be cheap.  However, the savings from avoiding probate and transferring assets tax efficiently make this expenditure necessary.  It's hard to convince older people to part with a lot of hard earned dollars to do this, but it's your and your brothers' job to convince them to do this.

Since you mentioned this; What is the benefit/difference of a revocable versus an irrevocable trust?

jeromedawg

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Re: Feedback on inheriting real estate investments
« Reply #6 on: November 30, 2017, 09:04:41 AM »
Real quick, just wanted to address the question regarding "Why doesn't your dad just sell the place and gift you the proceeds?" - one of his primary goals here is to tax shelter or reduce tax liability as much as possible. If he sells, he'd owe cap gains, which I'm pretty sure he's wanting to avoid. By gifting us the property outright, wouldn't he be able to avoid this (in which case, we would then have the burden)?


EDIT: He just went back to saying "So that's why I said I'd gift it to you three then you can 1031-exchange it for something else"
« Last Edit: November 30, 2017, 09:48:35 AM by jeromedawg »

jeromedawg

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Re: Feedback on inheriting real estate investments
« Reply #7 on: November 30, 2017, 03:08:47 PM »
My dad just sent me a packet on doing a 1031 exchange for a "DST"(Delaware Statutory Trust) investment property. I'm a bit wary on them doing that - he said he'd only do this if we didn't want to be gifted the real estate...

Another Reader

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Re: Feedback on inheriting real estate investments
« Reply #8 on: November 30, 2017, 03:42:11 PM »
Irrevocable trusts are rare.  Sometimes they are used to keep assets away from the government to qualify for Medicaid for nursing home care.  A revocable trust can be changed while the trustors are alive.  Again, you or rather your parents, should be talking to an estate planning attorney about this.

Aimza

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Re: Feedback on inheriting real estate investments
« Reply #9 on: November 30, 2017, 04:07:19 PM »
Irrevocable trusts are rare.  Sometimes they are used to keep assets away from the government to qualify for Medicaid for nursing home care.  A revocable trust can be changed while the trustors are alive.  Again, you or rather your parents, should be talking to an estate planning attorney about this.

My parents put their house in an irrevocable trust in my sister and my names in case they have to go into long term housing - this way the house cannot be used as an asset.  I don't know what other benefits there are to this and we never considered tax implications in the future. I guess I should have researched it better. Sigh.

jeromedawg

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Re: Feedback on inheriting real estate investments
« Reply #10 on: November 30, 2017, 09:25:56 PM »
Is it possible, under the $14k annual gift exclusion, to have my parents just start gifting us portions of their real estate to us? And if so, how would this be done? Would they literally just put all our names on the title at X% ownership? But then they'd have to change the title every year to reflect the portion percentage ownership, etc. Hmmm

jwright

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Re: Feedback on inheriting real estate investments
« Reply #11 on: December 01, 2017, 08:32:26 AM »
So you do need to know what your parents paid for it because that will determine your basis in the property and inform you as to the potential gains you will realize upon sale. 

In your last post, you do describe a common strategy.  The parents put the property into an LLC or FLP; the parents own the majority interest.  The parents then gift a percentage of the partnership to children each year.  Eventually the children own the majority and then the LLC interest in full.  You would operate the property as a business with the LLC as the owner. 

Also, even if you parents gifted the entire property, more than $14k per sibling, that doesn't mean they have to pay gift tax.  That means they have to file a gift tax return.  That essentially means they are tracking their lifetime exemption which is $5.49M per individual.   If they gift the $475K, then the lifetime limit is reduced to $5.02M but no tax is due.  This is all reconciled upon their death with the estate tax.

jeromedawg

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Re: Feedback on inheriting real estate investments
« Reply #12 on: December 02, 2017, 07:54:38 PM »
Thanks all.

My dad keeps redirecting me to understand articles about gifting, like this one: https://www.marketwatch.com/story/how-to-give-your-home-to-your-children-tax-free-2015-02-23

That article seems to be regarding potential strategies for primary residences. I'm not sure why he's asking me to 'interpret' it for his understanding. I told him he should really be explaining his overall intentions to his CPA and estate attorney and asking for a solution(s) on what's best. This is pretty overwhelming because it seems he's cherry-picking questions with them on specifics like "how much can I gift in a year" etc.

If I understand correctly, his main intentions are this:
1) Transfer his real estate investment assets to his three sons or at least keep them within the family while
2) reducing his/my mom's and our tax burden and liability

Is it fair to encourage him to ask his CPA and lawyer these questions rather than having all of us (mostly just me) researching all this? It seems one way to do this would be by forming an LLC, which he has already alluded to (if this is the best way to do it, I'm not sure why he's still asking questions and particularly to us).
« Last Edit: December 02, 2017, 09:31:40 PM by jeromedawg »

msheldon

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Re: Feedback on inheriting real estate investments
« Reply #13 on: December 02, 2017, 11:03:45 PM »
If the "gift" is done at the time of death, you get a stepped up basis. If you immediately sell, no taxes are due. If the gift is done now, aren't you at the current basis? So taxes are due when sold. Ostensibly this is being done to minimize taxes, right? I feel like I'm missing something...

Perhaps the goal is "we're getting tired of being landlords and think you kids should get into this business"?

jeromedawg

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Re: Feedback on inheriting real estate investments
« Reply #14 on: December 02, 2017, 11:42:32 PM »
If the "gift" is done at the time of death, you get a stepped up basis. If you immediately sell, no taxes are due. If the gift is done now, aren't you at the current basis? So taxes are due when sold. Ostensibly this is being done to minimize taxes, right? I feel like I'm missing something...

Perhaps the goal is "we're getting tired of being landlords and think you kids should get into this business"?

So what impact (or benefit) does putting all this into an LLC have?

More of it is this: "We don't need the extra income from these rentals and if you guys don't want them we're going to reinvest them into a DST. Otherwise, if you guys could use the extra income then please take it all and do as you please but let's figure out how to minimize the taxes and shelter as much as we can"

SeattleCPA

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Re: Feedback on inheriting real estate investments
« Reply #15 on: December 04, 2017, 06:45:44 AM »
I see no mention of the Sec 1014 step-up in basis in  thread above which would be a really significant issue to consider here, too.

I.e., if your mom and dad bought property in 90s, and fully depreciated it, leaving property in estate to get at least one Sec. 1014 step-up would be worth considering... (After step-up, you would sell with no capital gain or restart depreciation using fair market value rather than original cost.)

This blog post, among other things, explains the "step-up in basis" thing in the section labeled, "Step-Up in Basis Beats Stretch IRA Option":

https://evergreensmallbusiness.com/real-estate-vs-ira-and-401k-accounts-part-i/

Remember, too, that California is a community property state so step-up occurs when first spouse in a marriage dies.
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nereo

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Re: Feedback on inheriting real estate investments
« Reply #16 on: December 04, 2017, 07:05:01 AM »

Is it fair to encourage him to ask his CPA and lawyer these questions rather than having all of us (mostly just me) researching all this? It seems one way to do this would be by forming an LLC, which he has already alluded to (if this is the best way to do it, I'm not sure why he's still asking questions and particularly to us).

Well.... it depends on the relationship you have with your father, but given he's the one gifting something valued at ~$450,000 I don't think it's out of the question for you to do some of the legwork and come up with the best tax strategy for everyone involved.  I'm clearly not a tax expert, but if it were me I'd find a CPA who has experience in these matters and schedule a meeting to get his/her take.  It might cost you several hundred $ in fees but has the potential of saving you tens-of-thousands in taxes if done wrong.  I'd also split (deduct) the fee from the eventual sale so your brothers would wind up covering 2/3rds of it.
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Blindsquirrel

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Re: Feedback on inheriting real estate investments
« Reply #17 on: December 04, 2017, 07:07:42 PM »
  Vote for CPA also, recapture of depreciation will be murder on that place. It has been held so long that he is probably way better to hold it until he passes, then the cost basis steps up to value at time of death.
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