Wednesday, April 13, 2011

Inherited a House?

When buying any home, make sure you are not doing it for emotional reasons.  Buying the family home is often freighted with more emotions than logic.

NOTE:  A lot of people find this posting after searching on "I inherited a house, what is the inheritance tax on that?"

Consult your tax adviser for more details.   Generally, you get a "stepped up basis" in an inheritance, which means it is deemed that what you "paid for" the house is its market value at the time you inherit.  So if you sell it, there is no capital gains.

Estate taxes, as the name implies, are paid by the estate - the dead person, not you.  For most middle-class folks, there is an exemption that excludes you from paying Federal Estate Taxes (the "Gifts and Estate Tax") but consult your tax adviser to see if you are covered.  There may be State Estate taxes to consider as well.

Some States may have an inheritance tax, however, so consult your tax adviser as well, too.

But in general, most of us "little people" pay little or nothing in terms of Federal Taxes on inheritances.

If you don't have rich parents, of course, this all seems terribly unfair.

A Reader Asks:

"When someone dies, and you don't want to sell their house to pay off debts, what should you do?"

Short answer:  Get a mortgage and Buy it.   But make sure you really want it, first.

While it is possible for wily Estate Executors to keep an Estate in Probate for years on end, and thus effectively have use of the house and other possessions of an Estate, in the end, eventually the house will have to be transferred to someone else.

This can be a transfer through the Estate (by will or through intestate succession) and/or by purchasing the interests of the other heirs.  And this can get messy, so make sure this is really what you want to do, and not some act of nostalgia, and thus an example of emotional thinking.

Lets use some examples to illustrate.

1.  Sam inherits his parents house, which is unencumbered (no mortgage).  Sam is an only child and the only heir.  This is a simple example.  The title to the house passes to Sam once Sam has probated his parent's Estate.  He is now proud owner of his childhood home.

Of course, Sam lives in another State now, and the childhood home is merely a tract home in a subdivision where he grew up.  Sam has no use for such a home, nor does keeping it make any sense.  He has some minor repairs made to put the home in order, has it cleaned from top to bottom, sells off what furniture and possessions he doesn't want, and then has a Real Estate Agent list the home for sale.  The home sells quickly, as Sam prices it realistically, and the money received adds nicely to his nest egg for retirement.

A similar situation happened to Suzie.  But Suzie decided to keep the home for emotional reasons, thinking that a mass-produced crackerbox in the suburbs had "memories" attached to it.  Suzie visited the house maybe once a month, after driving hours to see it.  The taxes and insurance and utilities cost her $10,000 a year or more.  And as the house was vacant, it slowly degraded over time and was vandalized and broken into.

She tries renting the house, but she wants to keep her family's "precious heirlooms" (particle board furniture, a broken TV set) in the attic, and Suzie screams at her tenants whenever she finds "evidence"  they have been in the attic.  The tenants move out - not wanting to live in a house where the landlord comes by every month to weep quietly in the backyard.

You may think I am making up Suzie.  But people like her exist - and one way Abandoned House People are created.  Keeping a property worth hundreds of thousands of dollars, for emotional reasons, is idiotic.  And the best way to deal with the death of your parents is to grieve and then move on with your life.  Staying in emotional stasis by hanging on to "things" is idiotic.

And yes, people do this with other possessions, such as cars.  I knew a lady who kept her dead son's car in the driveway for five years, until it finally became a rusty, dirty eyesore with flat tires.  Not only did she lose a lot of money this way (several thousand dollars), it was a constant reminder to her of her son's death.  She told herself that she was comforted by seeing it there every day, but in reality, it was a constant reminder to her every night when she came home of the tragedy in her life, which of course made her depressed.

The dead don't want us to spend the rest of our lives mourning.  If you really believe all that religion crap, well, you're going to see them in a few short years, anyway, right?  So move on.  And yea, I know, that sounds "harsh".  But there it is.

Never keep expensive things of a deceased loved one for emotional reasons!

2.  Fred, Wilma, and Barney are siblings who inherit their parents house, which has a mortgage.  The Estate also has other debts to pay, such as the balance on their Mother's car loan.  Wilma, who has saved nothing in life and is the oldest, wants to keep the house for herself.  Fred and Barney want to sell the house, so they can put that money in their 401(k) account.

This situation, I suspect, is closer to the scenario in the reader's question than the first scenario.

Presuming Fred and Barney are willing to go along with Wilma's plan, there are a number of ways this could play out.

If Fred and Barney insist on being paid for their share of the house, then Wilma will have to buy them out - either by getting a mortgage or paying them in cash (if the Estate has any liquid assets that Wilma has a share of).  In addition, of course, the mortgage will have to be paid off, either through other moneys from the estate, or by Wilma's mortgage.

But frankly, if their parents had any money at all, then chances are they wouldn't have a mortgage and car loans.  So I suspect there is not enough money in the Estate to pay off the mortgage.  And if Fred and Barney insist on getting their share of the profits from the home, well, then Wilma will have to get a pretty hefty mortgage to buy their parent's house.

At this point, Wilma should think carefully about why she is doing this.  After all, buying a house is a big decision, and if you are buying your parents house, are you doing so because you really want it, or for emotional reasons, or because you think it is some sort of bargain?

As I have noted before, when you are "shopping," you are presented with a single product at a presented price and then decide whether you want it.  But if you really want a real bargain you should decide whether you need something, then go compare various goods on quality and price and then make an informed purchase.

And so with buying a home - you should look at several houses and decide which one is right for you, as opposed to looking at just one and then deciding whether or not to buy it.  Looking at one house only would be idiotic, right?

But in effect, that is what Wilma is doing here - making a decision to buy a house without comparing quality and price.  And then throwing in the emotional freight of buying the family home, well, chances are, it isn't a very smart financial move.

And again, most family homes today are merely suburban tract homes that the parents bought to have a place to live.  These are not the family homesteads of yore - the home on Walton Mountain that was passed through generations of family members since the Civil War.  And even if it was, are you buying the house because you feel an "obligation" to "keep it in the family" or are you buying it because you really want it?

Or are you buying it for the perceived status of owning an old family home and having "roots" and such?  Because status is often the worst reason to do anything.

The ancillary issue here, is of course, that Wilma wants Fred and Barney to give her their shares in the house on the grounds that they are "lucky" (having saved their money) and that she is "needy" (having squandered her money) and thus deserves a huge handout.

That is, of course, a personal decision for Fred and Barney to make, but Fred and Barney should consult with their wives first, and listen to their wives in this matter, not their Sister, as their primary obligation is to their family (wife, children) not their childhood family (parents, siblings) and they need to make sure they don't screw up a lump sum payout.

In a situation like this, it is probably better for all concerned to sell the home, pay off the parent's debts, and then divide the proceeds according to the Will or Intestate Succession.  Wilma can then use that money to buy a home she wants, as opposed to one she is presented with as a choice.  And chances are, that home will be more practical and in a location that is more useful to her.

Fred and Barney can put their money into savings, which they will need to so, as no doubt Wilma will be begging for more money down the road.  Even if you subscribe to the "give money to needy siblings" theory of life, it is probably a better idea for you to keep the money and then dole it out as needed rather than hand over a lump sum to the needy sibling.  Because you know what the needy sibling will do with the lump sum - Hello Las Vegas!

But a better idea is to stop being an enabler of needy siblings and take care of your own family (yourself, your spouse, your children) first.

3.  Moe, Larry, and Curley inherit their parent's vacation cottage on Cape Cod, which is unencumbered.  Moe, living in Boston, thinks it would be a swell idea to "keep the house in the family" and proposes to his Brothers that they keep the house in their names, and they can all "share" it as a vacation home.

Of course, this bodes well for Moe, who is only a couple hours drive away (on the weekends, the traffic is murder!).  But Larry lives in New York City and can rarely get away to the Cape, except perhaps for a week or two in the summer.  And Curley lives in California and hasn't been "back East" in years, except to attend his parent's funeral.

Moe's idea is idiotic and clearly self-serving.  Moe will get a weekend house and have his Brothers pay for 2/3 of the upkeep.  And keeping the house for emotional reasons, of course, is stupid as well.

Moe pitches the idea that it could be an investment for them - that it will appreciate in value over time.  But such thinking is flawed.  While it may appreciate in value over time, the upkeep, taxes, utilities, insurance (including wind and flood policies on the Cape!) will drown out any appreciation.

So Moe comes up with another idea - they can rent it out on the weeks and weekends when they are not using it, and that will pay for the overhead.  This is also a flawed idea, as in many cases, the rent received from vacation homes barely covers the overhead.  And moreover, if the house is rented out at peak times, it defeats the idea of "keeping the home" for a personal vacation retreat.  And of course, Moe is going to take all the best weekends for himself, which means the rental income will barely cover the property taxes.

Larry and Curley aren't idiots, and they see through their Brother's machinations easily.  Hey, they've known Moe for decades and know the score with him.

So, Moe makes a final pitch - he will buy out Larry and Curley's shares in the house and then own the house himself.  Moe tells Larry and Curley what he thinks the house is worth, and offers to pay them 1/3 each that price, after securing a mortgage from a local bank.

But Larry goes online and notes that the identical house next door sold for $200,000 more than Moe's stated price, only a few months before.  So the three Brothers agree to get an Appraisal done on the house.

The Appraisal comes in at a price far higher than Moe's low-ball offer.  Larry insists that if Moe wants to buy the house, he has to pay 1/3 of the Appraised value to him and Curley each.  Moe balks.

Curley steps in and notes that since they are not listing the home with a  Real Estate Agent, they are saving a 6% commission and should lower the effective price by at least that amount.  Curley also points out to Larry that the home would need to be painted and updated if it were to be put on the market (it needs a new roof and hot water heater, for starters) and moreover that all the junk in the house would have to be cleaned out.  If Moe buys the house "as is" then Larry and Curley will save considerable time and money in the deal.

So the three Brothers agree on a price that is less than market value, and thus a "bargain" to Moe, but represents more cash-back to the other two Brothers - and a quick, painless sale as well.  Moe gets a mortgage for 2/3 this value (or uses his inheritance to pay cash) and pays each Brother half of that.  And everyone is happy.

And this is not a bad scenario.  As Curley points out to Larry, not only will marketing the house be cumbersome and expensive to do, it will be time consuming, as vacation homes can languish on the market for months, even years, if you want to get "top price".  Moreover, if Moe really wanted to, he could be a real pain-in-the-ass on the sale of the home or the settlement of the Estate.  Getting Moe to agree to a scenario that gives the remaining two Brothers more money - instantly - is not a bad move.

Larry finally agrees.  His only sticking point was an emotional issue - he thought Moe was "getting away" with something by getting the house for cheap.  And such an emotional issue is, of course, tied up in decades of family baggage.

* * * 

The point of these scenarios is this:  The actual mechanics of buying or dividing up the family home are really rather trivial - any competent Real Estate or Estate Attorney can handle the paperwork for you for a nominal fee (shop around on price!).  Contact an Attorney in your jurisdiction for more details.

The real issues are the emotional ones and the family ones.  Getting multiple heirs to agree on one course of action can be problematic, and if one heir wants to be a stick in the mud, he can throw a wrench in the works, particularly if he or she is the Executor of the Estate.

The legal issues are routine and readily resolved.  It is the emotional issues that often tie up Estates for years and cause no end of grief.  And for this reason, just selling it all and dividing up the proceeds is often the best choice.  I have seen Estates abandoned for decades when family members cannot agree on a course of action.  And it is silly and such a waste.  That money, invested, could make every family member comfortable for life.  But instead, it all goes to waste.

And these examples illustrate the inherent evil in inherited wealth - while parents might want to say they are "doing good" by bequeathing an Estate to their kids, oftentimes these bequests end up causing all sorts of emotional friction between siblings.  And of course, everyone says "its not about the money, its the principle of the thing!"

But it is about the money - the principal and the interest of the thing.  And I've seen scenarios like this blow up and result in a lot of bad blood.

And that is another good reason right there, if you are an average middle-class person, to think about selling the family home as you age, and move into a smaller retirement house or apartment.   It will be less hassle for your kids to deal with when you die (no house to sell or subdivide) and odds are, the kids won't be fighting over the rights to your retirement apartment or your condo in retirement village.

And of course, the best option is to leave less as an inheritance.  Giving away money to people only trains them in dependency - and the more you give them, the less successful they will be on their own.

I am fortunate that I was able to afford to walk away from all that - and that is always an option.  If you have your own Estate - your own wealth - you can just walk away from messy, sticky, family inheritance problems, as you truly don't need the money. 

* * *

P.S. - before making any major decision, be sure to consult a Trusts and Estates Attorney AND a Tax Adviser.  While Federal Gifts and Estate Tax exempts most middle-class people from ever paying a penny, in some jurisdictions, the State taxes can be murder - as much as 1/3 of the Estate before it is all said and done - and there are not only Estate Taxes (paid by the State) but Inheritance Taxes (paid by you).

So while it may seem all romantic and emotional to "keep the family home in the family", you may end up discovering that by the time the tax man is through, it simply isn't possible to do.  Again, liquidating everything is usually the easiest and best decision with most Estates.