Inheriting $4mil home

[HermanCain]

I will be inheriting a home worth roughly $4 million dollars in CA. It has a tax assessment that results in taxes of only $4000/yr due to prop 13. It's in a "high-end" destination where rooms rent for roughly $4000/month. This would theoretically result in a yearly revenue of $200,000 or at a cap rate of 4%, a real value of somewhere around $5 million to me. It overlooks the ocean with prime views and is safe from sea level rise, so its value may go up even more when homes south of the PCH crumble into the ocean.

I'm aware that any transition into equities will result in a loss of roughly $1 million of value if you account for the low tax base. But I'm also aware that if I did have around five million dollars, I would probably go out and purchase a house very much like the one I have. I'm also going to continue to work...I'm just starting my career. Finally, I do not have expensive tastes, so having a whole bunch of equities generating income doesn't really matter to me. I really like this house; it's sort of a family heirloom, and kind of want to just keep it.

Am I making a mistake? Is such a non-diversified asset problematic?

To those of you paying much higher taxes on a higher assessment...please don't hate. My family has paid into CA tax coffers for decades and are pretty committed to the state in spite of its issues.

[trollwithamustache]

who do you think would pay you 4 large a month to have non super model roomates? 

[jlcnuke]

I will be inheriting a home worth roughly $4 million dollars in CA. It has a tax assessment that results in taxes of only $4000/yr due to prop 13. It's in a "high-end" destination where rooms rent for roughly $4000/month. This would theoretically result in a yearly revenue of $200,000 or at a cap rate of 4%, a real value of somewhere around $5 million to me. It overlooks the ocean with prime views and is safe from sea level rise, so its value may go up even more when homes south of the PCH crumble into the ocean.

I'm aware that any transition into equities will result in a loss of roughly $1 million of value if you account for the low tax base. But I'm also aware that if I did have around five million dollars, I would probably go out and purchase a house very much like the one I have. I'm also going to continue to work...I'm just starting my career. Finally, I do not have expensive tastes, so having a whole bunch of equities generating income doesn't really matter to me. I really like this house; it's sort of a family heirloom, and kind of want to just keep it.

Am I making a mistake? Is such a non-diversified asset problematic?

To those of you paying much higher taxes on a higher assessment...please don't hate. My family has paid into CA tax coffers for decades and are pretty committed to the state in spite of its issues.

If you can realistically get $200k in gross rent/year, you'd likely have a gross return exceeding that which you'd get by liquidating the home and investing the results. Sure, there are potential problems (the real estate market there could go the way of Detroit) but that's a risk decision you have to make for yourself. Of course, there's also the questions of how are you going to setup and manage the place as a rental (yourself, property management company), how you're going to finance repairs etc until you've accumulated rental income, etc. but none of those are overly difficult things to figure out if you'd like to rent the place out. Perfectly plausible plan imo.

What level of risk/involvement are you willing to do? The "easiest" option long-term would probably be to sell it and invest the proceeds in a well-diversified portfolio. The rental option could work out better overall however, though it's likely to be more work to accomplish it. So I'd say it's all about what you'd rather have/do.

[mm1970]

I live in Santa Barbara.

If I inherited a $4M home with a $4k tax basis?  I'd keep it.

Yes, it's kind of an emotional thing - prob makes no sense.  Not sure of your location, so unsure if $200k a year in rent is realistic or not.

[HermanCain]

who do you think would pay you 4 large a month to have non super model roomates?

Oh I would not live in it with them. In fact, I think confidential rentals are the norm in this area, so it's possible I wouldn't even know who was renting it.

A few known A-list movie stars have rented it in the past (they did trash it and were horrible).

[HermanCain]

I live in Santa Barbara.

If I inherited a $4M home with a $4k tax basis?  I'd keep it.

Yes, it's kind of an emotional thing - prob makes no sense.  Not sure of your location, so unsure if $200k a year in rent is realistic or not.

Think Montecito/Malibu/PP/Newport with good sized plot, safe from mudslides/sea level rise, views..all the good stuff. only negative is it's on the land side of the PCH so there's a little bit of road noise, but in a few decades I think we'll be having the last laugh (jk global warming is serious business and i am not applauding anyones' loss of property)

[inline five]

My one and only primary concern is how to limit liability in a lawsuit. People with that sort of property value have a target on them. Talk to a lawyer about putting it in some form of LLC to protect yourself first and also protect the home. CA also has horrible renter laws which allow squatters to sit for soemtimes years in a home and never pay rent.

Good situation to be in though.

[ol1970]

 “Sure, there are potential problems (the real estate market there could go the way of Detroit)
[/quote]

peoples perception of Detroit is always interesting to me, the real estate market is actually on fire in Detroit and has seen better returns than SF.  A condo that couldn’t be given away for $80k 7 years ago now fetches $600k and sells in a day.  Granted I wouldn’t touch it with a 10 foot pole nor live in the city, but just interesting to point out that Detroit real estate has gone crazy.

To the OP, I live in a multimillion dollar home myself, life’s about living, I say keep it.  Especially if it doesn’t burden your lifestyle to maintain it.

[Sibley]

I believe under Prop 13 that they can revalue the property if you do significant enhancements on it, or if it sells. I do not know the rules on inheritance. If it would reset value to current market, your taxes will be way more than $4k. Might want to double check that.

Personally, I'd sell the house. Because you'll be getting it via inheritance, there will be a step up of basis to market value as of the date of death, so your gain/loss taxes should be minimal if you sell relatively quickly. But I'm not interested in being a landlord or filing taxes in CA if I don't have to.

[EricEng]

Personally, I'd sell the house. Because you'll be getting it via inheritance, there will be a step up of basis to market value as of the date of death, so your gain/loss taxes should be minimal if you sell relatively quickly. But I'm not interested in being a landlord or filing taxes in CA if I don't have to.

This is great advice.  You can sell it right away with no tax loss if inherited as your tax basis does step up.  CA has no inheritance tax either.

Based on your comment about being early in your career, managing and maintaining a $4mill rental might be a bit much.  Far easier to cash out with no loss and just do some easy index investing.  Lot less stressful than worrying about what damage some drunken renter has done during a party.  You are rich now, why give yourself pointless stress?

[HPstache]

If it were me, I would sell it, move to a low-ish COL area and FIRE immediately

[jinga nation]

A. Why do you think other homes south of PCH will crumble into the ocean while yours overlooking the ocean will be safe? Will yours be safe from earthquakes or canyon/forest fires or environmental hazards?

B. Houses are not heirlooms; they require constant upkeep. Don't focus on the low taxes, focus on maintenance costs. Surely a house that brings in $4k/room/month has high standards to meet. If you gross $200k/yr in rent, what will the maintenance costs be? Will you be leasing rooms month-to-month or long-term? Expensive homes means expensive property management, especially in California.

C. Did you grow up in the home? Nostalgia is tough and emotional heart-strings can cause rash/bad/good decisions. Run the numbers. Do you think you'll move into the house 5,10,15 years from now. If you were to have children, would you want them to live there?

D. What would prevent you from moving into the house right now and keep one room, rent out the others, and get to ensure everything runs well? Have you rented out rooms previously? It pays to be in the operational theater and learn the basics of renting before you turn over to a property manager.

E. Congratulations on the inheritance. I lived in SoCal for one summer and loved the canyon homes north of LA with beautiful views. Enjoy it for while if you do decide on selling.

[Jrr85]

I will be inheriting a home worth roughly $4 million dollars in CA. It has a tax assessment that results in taxes of only $4000/yr due to prop 13. It's in a "high-end" destination where rooms rent for roughly $4000/month. This would theoretically result in a yearly revenue of $200,000 or at a cap rate of 4%, a real value of somewhere around $5 million to me. It overlooks the ocean with prime views and is safe from sea level rise, so its value may go up even more when homes south of the PCH crumble into the ocean.

I'm aware that any transition into equities will result in a loss of roughly $1 million of value if you account for the low tax base. But I'm also aware that if I did have around five million dollars, I would probably go out and purchase a house very much like the one I have. I'm also going to continue to work...I'm just starting my career. Finally, I do not have expensive tastes, so having a whole bunch of equities generating income doesn't really matter to me. I really like this house; it's sort of a family heirloom, and kind of want to just keep it.

Am I making a mistake? Is such a non-diversified asset problematic?

To those of you paying much higher taxes on a higher assessment...please don't hate. My family has paid into CA tax coffers for decades and are pretty committed to the state in spite of its issues.

A couple of thoughts:

First, something seems off about the valuation or the rent.  If it's a $4,000,000, the one percent "rule" would say you would be looking at something closer to $40,000.  So if you could gross $200,000, it seems like the property should be worth way more than $4,000,000.  I know the 1% rule is just a screening tool and that some places people need 1.5 or 2% to make a good rental property and other places can make a good rental property at .5%, but usually the higher cost, higher appreciation areas end up with rents below 1%.  So I'd really dig into that with somebody that is an expert in the area, particularly before listing the house if that's the route you go.

Second, if you have a decent career path that would allow you to cover the carrying costs of the house, you can probably handle the "risk" of having that much money in one asset.  As long as you adequately insure yourself and the proeprty, the only real risk is that the housing market crashes and you end up with a $2M property.  The next worst case scenario is that you end up with a litigious squatter and yhou have to go borrow against the house to pay for attorneys fees.  The next worse case scenario would be an uninsurable event making the house worthless.  Only thing I can think of would be mold, which I wouldn't think would be a problem in that climate? 

Third, if you really want to get aggressive, you could take out a mortgage for maybe half the value of the house, invest it in the stock market, and then you get the benefit (or harm) of leverage on the property.  Or even more aggressive, take half the value in a mortgage and go purchase a bunch of cash flowing rental property with a 30 or 40% down payment.  Then you'd suddenly have $8M of real estate that should be on pace to be paid off in 15 years.  I probably would not do this with current stock valuations and with real estate being on a tear for almost a decade now, but it's an option.

 

[Another Reader]

If this is a transfer of a primary residence from parent to child, it can be excluded from revaluation at market value for assessment purposes, as long as you file the request for exclusion timely.  You can retain the base year value and the taxes on that base.  However, if the property is not the parent's primary residence, there is a limit of $1,000,000 on the value transferred.  If the house is worth $4,000,000, you would be taxed 25 percent on the old base and 75 percent on the new base.  Under those circumstances, selling might be more appealing.

[SwordGuy]

Real estate investment is all about the numbers.

I mention this because I just don't see how a rent of $4000 per month equals $200,000 in rental revenue per year.

By my calculation, that's (at most!) $48,000 a year in gross rents.   Even in Ethiopia, which has 13 months in  year, you won't get to $200,000  year! :)

You won't get to keep all that, there is property tax, insurance, property management, repairs, set asides for future repairs, some utilities, and you can't count on it renting out 12 months every year, either.

If you clear $4,000,000 on the sale of this property (to be very conservative) and invested it in Vanguard VTSAX and VTIAX, you could count on an income of $160,000 a year at a very conservative 4% safe withdrawal rate.  If you clear more, even better.

The only way this would make more money by renting would be if it appreciated in value substantially and then you sold it off.   Unless you really know that real estate market, that's a speculation not an investment.

So, unless you've made some really important typos on the numbers you presented to us, selling is the clear financial choice.   

Unless I had a burning need to live in that specific house in a few years, I would sell.

[PDXTabs]

I would sell it, put it all in VTWSX, and be sipping coffee in Lisbon within the month. You are of course free to live your own life.

[rpr]

It seems to me that the confusion is due to the fact that the $4000 rent per month was for each room. I assume there are 4+ bedrooms so annual rent = $4000*4*12 = $192000? Is it possible to rent on a per room basis here or must the whole house be rented for $16000 per month.

[trollwithamustache]

who do you think would pay you 4 large a month to have non super model roomates?

Oh I would not live in it with them. In fact, I think confidential rentals are the norm in this area, so it's possible I wouldn't even know who was renting it.

A few known A-list movie stars have rented it in the past (they did trash it and were horrible).

hmm, if you posted this a few years before I got hitched, I'd sign up for the 4k to live with a movie star for a while!

seriously, if you find someone willing to pay 200k in rent, they are gonna expect some legit landlord service from you. Are you ready to be that responsive?

[Bicycle_B]

From the viewpoint of securing early retirement, do a more careful evaluation of the costs and risks of maintaining it as a rental.  If the true net income of keeping it is more than your current cost of living, and more than your expected future cost of living (if you marry, for example), then whether you sell or not is irrelevant to your retirement:  you're FIRE now, assuming the effort of maintaining it fits in with your vision of retirement.  You keep your job and current lifestyle, adding the label of SWAMI.

http://www.mrmoneymustache.com/2011/04/30/weekend-edition-retire-in-your-mind-even-if-you-love-your-job/

I would venture that full Mustache chops would come from some Stoic effort towards making the maintenance ecologically efficient, and continuing to develop your own skills and projects in healthy ways.

[thunderball]

If it were me, I would sell it, move to a low-ish COL area and FIRE immediately

this.

[SwordGuy]

Oh, I get the numbers now.  Do people really rent "a room" for $4000 a month?

Enough of them to keep the property occupied?

Because that's simply amazing.

I would still sell, but that's for 2 reasons:

1) Hate having all my eggs in one basket.  Much better to diversify.
2) You can really get enough people to keep the place full at that room rate?  Really? 

[HBFIRE]

Oh, I get the numbers now.  Do people really rent "a room" for $4000 a month?

In prime high end locations on the Pac ocean in Cali?  Absolutely.  And it's not really that crazy to do so if you have the funds.  Can make more sense financially than buying a property in a similar location.

[FallenTimber]

I think everyone is undervaluing the ability to rent this place. My friend rents their $700k house and grosses between $100k and $120k each year. And that’s without an ocean view in a tiny mountain town that very few folks have heard of.

With a view overlooking the ocean, thousands of California homes rent for $5,000 - $10,000 per NIGHT. Take a look at VRBO or AirBnB. Obviously nobody would ever pay $200k a year to rent a house, but that’s not what you’re looking to do. With a $4 million dollar home and the right view, you’re sitting on a gold mine.

Personally, I would absolutely keep it and rent it out for a few years (or more, if it goes well). You can always sell it later. I would live off of the rental income, hire a property manager to handle bookings, cleaning, and maintenance, and I bet you would still bring in a profit of over $100k per year after all was said and done.

My 2 cents.

[Sibley]

I looked into Prop 13 a bit. Not linking everything I found, just the one that had the answer I was looking for. Looks like depending on your relationship with the current owner, you may or may not have an assessment reset. So, if you do NOT fall in the exemption, then you'd end up paying property taxes based on the full market value at time of transfer. If you do, then the assessed value is carried over. Make sure you know which you are before making a final decision.

https://medium.com/@michaellevinson_64108/landlords-and-heirs-why-prop-13-isnt-just-unfair-it-s-un-american-20a8597cb37b



Edit:
Ok, ok, shoot me. I don't live in CA anymore. But there are limits to the rules, and whatever prop it is, make sure you know the impact on you. That's a LOT of money, you do not want to get it wrong.

[FINate]

Being pedantic here, but the exclusion of reassessment for RE transfers between parent and child is the result of Prop 58 and Prop 193 for grandparent to grandchild, not Prop 13. IMHO it's one of the most egregious and inequitable aspects of the property tax regime in a state that claims to be progressive. The wealthy benefit most, to the tune of hundreds of thousands of dollars per year, past down by generation, in perpetuity. That said, I don't hate you for it. Play the game well even if the rules are screwy.

If after all expenses and vacancies you can get more than you would elsewhere then sure, why not.

My only hesitation (which you mention) would be having so much specific risk. Housing values have passed the previous peak in many areas, which isn't predictive of the future but worth noting. It's always different this time :) So you either make peace with the tradeoff of higher specific risk and higher returns, or you sell and diversify which means slightly less risk and slightly less return. It's the classic risk/reward tradeoff implicit in every investment - there's no free lunch.

If true that you'd be able to cash out the $4M free and clear without cap gains taxes then I would be very tempted by this. The California budget is highly dependent on the highest income earners and there are some huge unfunded pension liabilities looming (worse than the official figures which assume overly optimistic investment returns). Personally, I'd be interested in diversifying out before the next recession when RE prices drop and the state comes looking for more revenue.

Whatever you decide, talk to a tax expert first.

[Padonak]

I would just hire a good tax accountant and a real estate broker, sell the damn thing, invest in something like 60% VTSAX/40% VBTLX, live off the dividends and slowly travel the world for awhile, then settle in a nice place somewhere.

I would also immediately change my career, no matter how successful and promising it is, to what Nassim Taleb calls a "flaneur". Maybe, like Taleb, I would also write a bunch of books calling out all kinds of idiots and "empty suits", though I think I'm too lazy for that. But that's just me.

[HermanCain]

Being pedantic here, but the exclusion of reassessment for RE transfers between parent and child is the result of Prop 58 and Prop 193 for grandparent to grandchild, not Prop 13. IMHO it's one of the most egregious and inequitable aspects of the property tax regime in a state that claims to be progressive. The wealthy benefit most, to the tune of hundreds of thousands of dollars per year, past down by generation, in perpetuity. That said, I don't hate you for it. Play the game well even if the rules are screwy.

If after all expenses and vacancies you can get more than you would elsewhere then sure, why not.

My only hesitation (which you mention) would be having so much specific risk. Housing values have passed the previous peak in many areas, which isn't predictive of the future but worth noting. It's always different this time :) So you either make peace with the tradeoff of higher specific risk and higher returns, or you sell and diversify which means slightly less risk and slightly less return. It's the classic risk/reward tradeoff implicit in every investment - there's no free lunch.

If true that you'd be able to cash out the $4M free and clear without cap gains taxes then I would be very tempted by this. The California budget is highly dependent on the highest income earners and there are some huge unfunded pension liabilities looming (worse than the official figures which assume overly optimistic investment returns). Personally, I'd be interested in diversifying out before the next recession when RE prices drop and the state comes looking for more revenue.

Whatever you decide, talk to a tax expert first.

When you adjust for inflation prices are actually below the peak. That being said, I remember 2008-2013 and nobody thought prices would go up again. It's a more volatile market than most, sort of like the stock market, but it has the best weather in the country and there is a reason it's so expensive. Also, there are union court cases going through the CA and US supreme courts that could significantly help out the pension crisis. Also just my personal take but I highly expect CA to go slightly red in 2018 in spite of whatever garbage you hear about in the media. There are many, many scandals coming out of the CA gov't that can be pinned on one party, and whenever that happens, change happens. The gas tax is another reason, I just paid $3.60 for gas here while in texas they pay $2. Wtf.

[HermanCain]

I would just hire a good tax accountant and a real estate broker, sell the damn thing, invest in something like 60% VTSAX/40% VBTLX, live off the dividends and slowly travel the world for awhile, then settle in a nice place somewhere.

I would also immediately change my career, no matter how successful and promising it is, to what Nassim Taleb calls a "flaneur". Maybe, like Taleb, I would also write a bunch of books calling out all kinds of idiots and "empty suits", though I think I'm too lazy for that. But that's just me.

It's funny you mention Taleb because right now I'm a math/stats person gunning for wall street. I'm happy to work on any interesting problem, no matter the sector. I personally don't like sensationalized statistics; I have an assortment of friends in the field and it always kills me inside a little bit whenever I hear (seemingly) smart people talk about things like AI/big data like it's magic. Most data is actually cheap and mostly useless, and most of the time you're a collaborator with actual experts, helping them visualize and articulate, rather than being the sole mastermind of whatever you're working on. Of course, wall st. is a different story. There, your models make money and if you make money for someone, you make money--it's the most meritocratic thing I can think of.

[HermanCain]

Being pedantic here, but the exclusion of reassessment for RE transfers between parent and child is the result of Prop 58 and Prop 193 for grandparent to grandchild, not Prop 13. IMHO it's one of the most egregious and inequitable aspects of the property tax regime in a state that claims to be progressive. The wealthy benefit most, to the tune of hundreds of thousands of dollars per year, past down by generation, in perpetuity. That said, I don't hate you for it. Play the game well even if the rules are screwy.

If after all expenses and vacancies you can get more than you would elsewhere then sure, why not.

My only hesitation (which you mention) would be having so much specific risk. Housing values have passed the previous peak in many areas, which isn't predictive of the future but worth noting. It's always different this time :) So you either make peace with the tradeoff of higher specific risk and higher returns, or you sell and diversify which means slightly less risk and slightly less return. It's the classic risk/reward tradeoff implicit in every investment - there's no free lunch.

If true that you'd be able to cash out the $4M free and clear without cap gains taxes then I would be very tempted by this. The California budget is highly dependent on the highest income earners and there are some huge unfunded pension liabilities looming (worse than the official figures which assume overly optimistic investment returns). Personally, I'd be interested in diversifying out before the next recession when RE prices drop and the state comes looking for more revenue.

Whatever you decide, talk to a tax expert first.

Here is an opinion piece (probably influenced by the sweet, sweet voice of Rupert Murdoch) about what is going on as we speak: https://www.wsj.com/articles/the-supreme-court-may-rescue-blue-state-finances-1519594908

[HBFIRE]

Also just my personal take but I highly expect CA to go slightly red in 2018 in spite of whatever garbage you hear about in the media.

God I hope you're right on this.  Please be right on this.

[Astatine]

If it were me, I would sell it, move to a low-ish COL area and FIRE immediately

+1 (or even MCOL and a fancy house. $4 million house is EXPENSIVE even for HCOL locations)

[Louis XIV]

Personally I'd sell it.
Taxes are only $4k but add in:

• Insurance for the building
• Landlord's insurance
• Maintenance on a $4m home
• Property  Management, accounting & legal fees to deal with running it

And your actual costs are well over $4k.

Not to mention dealing with the sort of tenants who would rent this place (sure, you'll have a property manager, but that doesn't mean you aren't going to have incredibly picky tenants who expect everything to be perfect and rectified INSTANTLY for the $xx,xxx/month you're going to be charging them)

Then there's the total lack of diversification... Personally I'd rather have at least 50% of it outside real estate & have the real estate portion spread over multiple homes, so that if I had a sewage pipe burst or a gap in tenancy, I don't lose 100% of my passive income stream or have to stress about the $xxx,xxx repair bills that tend to come along with hugely expensive properties..

[HermanCain]

I think based on the responses here and my aims the best thing to do would be short-term rentals as needed and then keeping it for personal use and depending on how this works out, keeping it or just selling it. I don't really need the cash and the thought of a permanent tenant actually sounds terrifying, come to think of it. Also I would like to exclaim how I don't like how tempting it is for someone at my young (20s) age looking at this as a retirement plan. It can distract me from achieving goals. So anyways, thanks for the inputs everyone

[FallenTimber]

I think based on the responses here and my aims the best thing to do would be short-term rentals as needed and then keeping it for personal use and depending on how this works out, keeping it or just selling it. I don't really need the cash and the thought of a permanent tenant actually sounds terrifying, come to think of it. Also I would like to exclaim how I don't like how tempting it is for someone at my young (20s) age looking at this as a retirement plan. It can distract me from achieving goals. So anyways, thanks for the inputs everyone

Good for you. It would be extremely easy and tempting to sell the house, pocket the cash, and never work another day in your life. But I respect someone who has the drive and ambition to put their goals first. Personally speaking, if I were to inherit a $4 million dollar home, I would use it as an opportunity to make far more money than $4 million. Then I could honor the legacy of the family member by doing great things with that additional money. Perhaps you could fund a charity, host an annual fundraising party at the house for a non-profit organization the family member loved, or just pay random acts of kindness with some of your profits.

If I had a $4 million dollar home I left to a family member, I would be disappointed if the only person they helped was themselves, and they used my own hard work to simply retire so they don’t have to work. But it sounds like this family member left the home to a young and extremely ambitious person.

Establish an effective vacation rental model (my previous post) first and make sure you can cover all expenses. Yes, they may be $100,000 per year, but that’s okay if you’re bringing in $250,000 each year. If you enjoy property management, that could become your full time job. If you have other goals and plans, hire out all of the major headaches and accept a lower profit amount.

Don’t get too hung up on real estate values. Yes, they could plummet and the house could be worth $1 million in another three years. But so what? This is an inheritance, not a house you paid $2 million for. And you’re young. If you keep the home for another 30 years, it may be worth $5 million, $10 million, or more.

Enjoy the ride. Pursue what you love. Chase after your goals and your ambitions. Perhaps take a few more risks than you might do otherwise if you didn’t have a $4 million house in your back pocket. And after 5, 10, 20, 30 years pass, then reevaluate your goals and decide what you’d like to do at each stage of your life.

[trollwithamustache]

Being pedantic here, but the exclusion of reassessment for RE transfers between parent and child is the result of Prop 58 and Prop 193 for grandparent to grandchild, not Prop 13. IMHO it's one of the most egregious and inequitable aspects of the property tax regime in a state that claims to be progressive. The wealthy benefit most, to the tune of hundreds of thousands of dollars per year, past down by generation, in perpetuity. That said, I don't hate you for it. Play the game well even if the rules are screwy.

If after all expenses and vacancies you can get more than you would elsewhere then sure, why not.

My only hesitation (which you mention) would be having so much specific risk. Housing values have passed the previous peak in many areas, which isn't predictive of the future but worth noting. It's always different this time :) So you either make peace with the tradeoff of higher specific risk and higher returns, or you sell and diversify which means slightly less risk and slightly less return. It's the classic risk/reward tradeoff implicit in every investment - there's no free lunch.

If true that you'd be able to cash out the $4M free and clear without cap gains taxes then I would be very tempted by this. The California budget is highly dependent on the highest income earners and there are some huge unfunded pension liabilities looming (worse than the official figures which assume overly optimistic investment returns). Personally, I'd be interested in diversifying out before the next recession when RE prices drop and the state comes looking for more revenue.

Whatever you decide, talk to a tax expert first.

Do you understand that the average California home owner voted prop 13 in so their average children could inherit the family home?  Even back then joe 6 pack was priced out of the market.

[FINate]

Being pedantic here, but the exclusion of reassessment for RE transfers between parent and child is the result of Prop 58 and Prop 193 for grandparent to grandchild, not Prop 13. IMHO it's one of the most egregious and inequitable aspects of the property tax regime in a state that claims to be progressive. The wealthy benefit most, to the tune of hundreds of thousands of dollars per year, past down by generation, in perpetuity. That said, I don't hate you for it. Play the game well even if the rules are screwy.

If after all expenses and vacancies you can get more than you would elsewhere then sure, why not.

My only hesitation (which you mention) would be having so much specific risk. Housing values have passed the previous peak in many areas, which isn't predictive of the future but worth noting. It's always different this time :) So you either make peace with the tradeoff of higher specific risk and higher returns, or you sell and diversify which means slightly less risk and slightly less return. It's the classic risk/reward tradeoff implicit in every investment - there's no free lunch.

If true that you'd be able to cash out the $4M free and clear without cap gains taxes then I would be very tempted by this. The California budget is highly dependent on the highest income earners and there are some huge unfunded pension liabilities looming (worse than the official figures which assume overly optimistic investment returns). Personally, I'd be interested in diversifying out before the next recession when RE prices drop and the state comes looking for more revenue.

Whatever you decide, talk to a tax expert first.

Do you understand that the average California home owner voted prop 13 in so their average children could inherit the family home?  Even back then joe 6 pack was priced out of the market.

Prop 13 was voted in because local governments were going nuts with increases and pricing people out of their homes. It wasn't directly about inheritance (hence the later props). There are many things I like about Prop 13 and I benefit from it. Something like it was necessary, but having a property tax advantage that gets passed down through generations is bad policy. It causes all kinds of distortions and inefficiencies as children and grandchildren hang on to houses they wouldn't normally keep just because of the tax benefit. Without Props 58/193 folks would still inherit houses, but would trigger reassessment. If they inherit a house free and clear they would still make a handsome profit, but pay more in taxes. Or, sell and cash out the value. Either way, they still get the value of the inheritance.

[FINate]

Being pedantic here, but the exclusion of reassessment for RE transfers between parent and child is the result of Prop 58 and Prop 193 for grandparent to grandchild, not Prop 13. IMHO it's one of the most egregious and inequitable aspects of the property tax regime in a state that claims to be progressive. The wealthy benefit most, to the tune of hundreds of thousands of dollars per year, past down by generation, in perpetuity. That said, I don't hate you for it. Play the game well even if the rules are screwy.

If after all expenses and vacancies you can get more than you would elsewhere then sure, why not.

My only hesitation (which you mention) would be having so much specific risk. Housing values have passed the previous peak in many areas, which isn't predictive of the future but worth noting. It's always different this time :) So you either make peace with the tradeoff of higher specific risk and higher returns, or you sell and diversify which means slightly less risk and slightly less return. It's the classic risk/reward tradeoff implicit in every investment - there's no free lunch.

If true that you'd be able to cash out the $4M free and clear without cap gains taxes then I would be very tempted by this. The California budget is highly dependent on the highest income earners and there are some huge unfunded pension liabilities looming (worse than the official figures which assume overly optimistic investment returns). Personally, I'd be interested in diversifying out before the next recession when RE prices drop and the state comes looking for more revenue.

Whatever you decide, talk to a tax expert first.

Here is an opinion piece (probably influenced by the sweet, sweet voice of Rupert Murdoch) about what is going on as we speak: https://www.wsj.com/articles/the-supreme-court-may-rescue-blue-state-finances-1519594908

I no longer have my WSJ subscription so can't read the entire article. But aware of the pending cases. I hope some sanity prevails and hope to see CA move, even if just a little, to a bit more red just to balance things out. But this life-long (40 years) CA resident is losing patience.

[EricEng]

I think based on the responses here and my aims the best thing to do would be short-term rentals as needed and then keeping it for personal use and depending on how this works out, keeping it or just selling it. I don't really need the cash and the thought of a permanent tenant actually sounds terrifying, come to think of it. Also I would like to exclaim how I don't like how tempting it is for someone at my young (20s) age looking at this as a retirement plan. It can distract me from achieving goals. So anyways, thanks for the inputs everyone

What is your landlord rental experience?  You sound pretty young and this rental stuff is new to you.  Short term is usually far more headache than long term in their destruction and damage because they just don't care.   Not to mention, this caliber of rental is far more complicated and risky than normal cheap rentals most people start out doing.

You are worried about a pile of money in an index fund distracting you from your work goals?  Wait until you get weekly calls about different things that failed in the house or the latest hole a renter made with their car through a garage wall, especially while you work on the East coast Wall Street job you want (time difference makes reaching contractors a headache).

[mm1970]

I live in Santa Barbara.

If I inherited a $4M home with a $4k tax basis?  I'd keep it.

Yes, it's kind of an emotional thing - prob makes no sense.  Not sure of your location, so unsure if $200k a year in rent is realistic or not.

Think Montecito/Malibu/PP/Newport with good sized plot, safe from mudslides/sea level rise, views..all the good stuff. only negative is it's on the land side of the PCH so there's a little bit of road noise, but in a few decades I think we'll be having the last laugh (jk global warming is serious business and i am not applauding anyones' loss of property)

I have a few friends with homes in the Montecito area (though one of them is out for months due to mud).  I'd keep it if it's not in a high fire zone.

[rocketpj]

Sucks to inherit anything, in my opinion.  If and when I inherit I'll be sad most of all.

That said, you are inheriting instant FI and the ability to choose a career based entirely on your interests and desires.  Want to be a small town librarian, a casual carpenter, a full time trout fisher, no problem.

[EricEng]

Sucks to inherit anything, in my opinion.  If and when I inherit I'll be sad most of all.

That is a another good point we have been avoiding.  Also, another reason to sell eventually instead of trying to manage renting that while dealing with the emotional aspect of loss.

[Bicycle_B]

I will be inheriting a home worth roughly $4 million dollars in CA. It has a tax assessment that results in taxes of only $4000/yr due to prop 13. It's in a "high-end" destination where rooms rent for roughly $4000/month. This would theoretically result in a yearly revenue of $200,000 or at a cap rate of 4%, a real value of somewhere around $5 million to me. It overlooks the ocean with prime views and is safe from sea level rise, so its value may go up even more when homes south of the PCH crumble into the ocean.

I'm aware that any transition into equities will result in a loss of roughly $1 million of value if you account for the low tax base. But I'm also aware that if I did have around five million dollars, I would probably go out and purchase a house very much like the one I have. I'm also going to continue to work...I'm just starting my career. Finally, I do not have expensive tastes, so having a whole bunch of equities generating income doesn't really matter to me. I really like this house; it's sort of a family heirloom, and kind of want to just keep it.

Am I making a mistake? Is such a non-diversified asset problematic?

To those of you paying much higher taxes on a higher assessment...please don't hate. My family has paid into CA tax coffers for decades and are pretty committed to the state in spite of its issues.

@HermanCain, have you gotten a professional assessment yet of the expenses involved in renting it out, including the cost of repair when renters trash it?

Fwiw, there is a rule of thumb that expenses in a real estate rental average half the revenue, where expenses include everything but mortgage.  It's just a rule of thumb, but if it applies to this property, $200,000 of revenue would produce $100,000 of profits.  Presumably this would make it equivalent to $2.5 million in financial investments, not $5 million.  If I were in your shoes, this would change my guess as to the best decision to make.

Cap rate in real estate IIRC is not based on revenue.  It's based on net operating income (revenue minus operating expenses).  The article below describes this as all expenses but the mortgage.

https://www.thebalance.com/how-to-calculate-capitalization-rate-for-real-estate-2866786

Best of luck however you proceed.  Personally, I'd dig a little deeper before deciding.  If you own a $4M business, make sure you understand it thoroughly.  If you don't want to dig into it, maybe that's a reason to sell.

[Institutionalized]

The gas tax is another reason, I just paid $3.60 for gas here while in texas they pay $2. Wtf.

LOL, that's what I paid for gas in CA when I lived there 15 years ago.  Why would it suddenly matter now?

[Reynolds531]

Assuming I'm not good looking enough to date a new hot chick every week after letting my brother and his son move into my Malibu beach house I would immediately sell and invest per above.

Also I don't know the first thing about writing jingles for TV commercials.

[Leisured]

I agree with those who recommend selling the property and investing in index funds, including property index funds for diversification.

There may be an emotional issue with selling the house, but to quote the late Australian billionaire Kerry Packer: 'at the right price, everything is for sale.'

Ii agree wit this quote from FallenTimber:
'Good for you. It would be extremely easy and tempting to sell the house, pocket the cash, and never work another day in your life. But I respect someone who has the drive and ambition to put their goals first. Personally speaking, if I were to inherit a $4 million dollar home, I would use it as an opportunity to make far more money than $4 million. Then I could honor the legacy of the family member by doing great things with that additional money. Perhaps you could fund a charity, host an annual fundraising party at the house for a non-profit organization the family member loved, or just pay random acts of kindness with some of your profits.'

$4Mill invested should return about $160K, so substantial charitable giving is possible.

Padonak, Nassim Taleb comes from Lebanon, part of the old French empire, and 'flaneur' is a French term,possibly slang, similar to 'boulevardier'.

[Kay-Ell]

The easiest, least risky thing to do is cash out the 4m and invest it.  But honestly, if you're interested in keeping this house and turning it into an income producing rental, it's worth giving it a try.  Even if it under performs, it's not like you're losing money on a house you PAID 4million for.  You like this house.  You like the idea of keeping it in the family.  And you aren't repulsed by the idea of landlording.  So why not give it a try?

I have a short term rental (small house in very desireable area, not a high end house like yours) that I've rented on Airbnb for about 18 months and honestly it hasn't been a headache at all.  I love the flexibility of being able to use it myself when I want to, or gift a few nights to friends and family when they want to takea vacation.  I also liked @Leisured's suggestion of using the house to host a fundraiser for a worthy charity once a year as a tribute to the person you're inheriting it from.  There are a lot of moving parts that you'll likely need to enlist the help of professionals on to get as clear a picture as possible, but if that sounds like a challenge instead of a headache then go for it.

[jinga nation]

Being pedantic here, but the exclusion of reassessment for RE transfers between parent and child is the result of Prop 58 and Prop 193 for grandparent to grandchild, not Prop 13. IMHO it's one of the most egregious and inequitable aspects of the property tax regime in a state that claims to be progressive. The wealthy benefit most, to the tune of hundreds of thousands of dollars per year, past down by generation, in perpetuity. That said, I don't hate you for it. Play the game well even if the rules are screwy.

If after all expenses and vacancies you can get more than you would elsewhere then sure, why not.

My only hesitation (which you mention) would be having so much specific risk. Housing values have passed the previous peak in many areas, which isn't predictive of the future but worth noting. It's always different this time :) So you either make peace with the tradeoff of higher specific risk and higher returns, or you sell and diversify which means slightly less risk and slightly less return. It's the classic risk/reward tradeoff implicit in every investment - there's no free lunch.

If true that you'd be able to cash out the $4M free and clear without cap gains taxes then I would be very tempted by this. The California budget is highly dependent on the highest income earners and there are some huge unfunded pension liabilities looming (worse than the official figures which assume overly optimistic investment returns). Personally, I'd be interested in diversifying out before the next recession when RE prices drop and the state comes looking for more revenue.

Whatever you decide, talk to a tax expert first.

Here is an opinion piece (probably influenced by the sweet, sweet voice of Rupert Murdoch) about what is going on as we speak: https://www.wsj.com/articles/the-supreme-court-may-rescue-blue-state-finances-1519594908

I no longer have my WSJ subscription so can't read the entire article. But aware of the pending cases. I hope some sanity prevails and hope to see CA move, even if just a little, to a bit more red just to balance things out. But this life-long (40 years) CA resident is losing patience.

You can read the archived article: http://archive.is/O7PWK

[HermanCain]

Being pedantic here, but the exclusion of reassessment for RE transfers between parent and child is the result of Prop 58 and Prop 193 for grandparent to grandchild, not Prop 13. IMHO it's one of the most egregious and inequitable aspects of the property tax regime in a state that claims to be progressive. The wealthy benefit most, to the tune of hundreds of thousands of dollars per year, past down by generation, in perpetuity. That said, I don't hate you for it. Play the game well even if the rules are screwy.

If after all expenses and vacancies you can get more than you would elsewhere then sure, why not.

My only hesitation (which you mention) would be having so much specific risk. Housing values have passed the previous peak in many areas, which isn't predictive of the future but worth noting. It's always different this time :) So you either make peace with the tradeoff of higher specific risk and higher returns, or you sell and diversify which means slightly less risk and slightly less return. It's the classic risk/reward tradeoff implicit in every investment - there's no free lunch.

If true that you'd be able to cash out the $4M free and clear without cap gains taxes then I would be very tempted by this. The California budget is highly dependent on the highest income earners and there are some huge unfunded pension liabilities looming (worse than the official figures which assume overly optimistic investment returns). Personally, I'd be interested in diversifying out before the next recession when RE prices drop and the state comes looking for more revenue.

Whatever you decide, talk to a tax expert first.

Here is an opinion piece (probably influenced by the sweet, sweet voice of Rupert Murdoch) about what is going on as we speak: https://www.wsj.com/articles/the-supreme-court-may-rescue-blue-state-finances-1519594908

I no longer have my WSJ subscription so can't read the entire article. But aware of the pending cases. I hope some sanity prevails and hope to see CA move, even if just a little, to a bit more red just to balance things out. But this life-long (40 years) CA resident is losing patience.

You can read the archived article: http://archive.is/O7PWK

My idea is that the GOP tax bill was purposefully designed to nudge blue-state liberals into the fiscal conservative camp. They have a point: why should anyone have to pay more than 10,000 at the state level, no matter your income? "blue states" shouldn't be allowed to become little nation-states, where people self-segregate into ideological camps, etc. The bill may even result in bringing people together by forcing them to be together.

Seriously, you have the state of CA making "treaties" with other countries for greenhouse gases (that won't do a damn thing..)

How this ties into the original post...that $4m in equity is something a lot of people have a lot of interest in taking away to generate revenue and placate a population. Which is why it may be a good idea to sell.

[EnjoyIt]

My one and only primary concern is how to limit liability in a lawsuit. People with that sort of property value have a target on them. Talk to a lawyer about putting it in some form of LLC to protect yourself first and also protect the home. CA also has horrible renter laws which allow squatters to sit for soemtimes years in a home and never pay rent.

Good situation to be in though.

Can I rent the place?

[snapperdude]

Being pedantic here, but the exclusion of reassessment for RE transfers between parent and child is the result of Prop 58 and Prop 193 for grandparent to grandchild, not Prop 13. IMHO it's one of the most egregious and inequitable aspects of the property tax regime in a state that claims to be progressive. The wealthy benefit most, to the tune of hundreds of thousands of dollars per year, past down by generation, in perpetuity. That said, I don't hate you for it. Play the game well even if the rules are screwy.

If after all expenses and vacancies you can get more than you would elsewhere then sure, why not.

My only hesitation (which you mention) would be having so much specific risk. Housing values have passed the previous peak in many areas, which isn't predictive of the future but worth noting. It's always different this time :) So you either make peace with the tradeoff of higher specific risk and higher returns, or you sell and diversify which means slightly less risk and slightly less return. It's the classic risk/reward tradeoff implicit in every investment - there's no free lunch.

If true that you'd be able to cash out the $4M free and clear without cap gains taxes then I would be very tempted by this. The California budget is highly dependent on the highest income earners and there are some huge unfunded pension liabilities looming (worse than the official figures which assume overly optimistic investment returns). Personally, I'd be interested in diversifying out before the next recession when RE prices drop and the state comes looking for more revenue.

Whatever you decide, talk to a tax expert first.

Here is an opinion piece (probably influenced by the sweet, sweet voice of Rupert Murdoch) about what is going on as we speak: https://www.wsj.com/articles/the-supreme-court-may-rescue-blue-state-finances-1519594908

I no longer have my WSJ subscription so can't read the entire article. But aware of the pending cases. I hope some sanity prevails and hope to see CA move, even if just a little, to a bit more red just to balance things out. But this life-long (40 years) CA resident is losing patience.

You can read the archived article: http://archive.is/O7PWK

My idea is that the GOP tax bill was purposefully designed to nudge blue-state liberals into the fiscal conservative camp. They have a point: why should anyone have to pay more than 10,000 at the state level, no matter your income? "blue states" shouldn't be allowed to become little nation-states, where people self-segregate into ideological camps, etc. The bill may even result in bringing people together by forcing them to be together.

Seriously, you have the state of CA making "treaties" with other countries for greenhouse gases (that won't do a damn thing..)

How this ties into the original post...that $4m in equity is something a lot of people have a lot of interest in taking away to generate revenue and placate a population. Which is why it may be a good idea to sell.

Why should blue states have to subsidize red states? How much extra in federal tax does a state like California have to pay to cover the amount that a state like Mississippi sucks out of the federal system? You want a level playing field? How about a rule that no state can take out more than they pay in? How about any deficit state lose half of there electoral college votes each election?