Leaving the House to the Kids: an Atherton CA Estate Planning Example
Posted by Janet Brewer on Sun, Jul 25, 2010 @ 03:28 PM
Meet "Mildred"
I have many clients in the Palo Alto area who would like to pass their homes on to their children as part of their estate plans. One client (“Mildred”) who lives in Atherton purchased her house in the early 1970’s for about $180,000. It’s now worth over $3.5 million and is mortgage-free. Mildred is a widow and has 3 adult children.
Mildred wants her estate to pass to her children in equal shares, but she wants her youngest “Suzie” to have the house. Suzie has lived with Mildred for several years and has taken care of her, so she thinks it would be “fair” if Suzie were to be able to stay in the house and buy out her siblings.
Mildred’s property taxes are about $2,700 per year. She knows that if her residence passes to her children, they get to keep her property tax rate under “proposition 13” (transfers of a personal residence from a parent to a child are exempt from increases in property taxes).
Sounds simple, right? Not quite.
Is the house the primary asset?
First of all, the house is Mildred’s primary asset. If Suzie inherits it, Mildred doesn’t have other assets that can be used to “equalize” the estate. That either means that Suzie ends up with an asset worth $3.5 million and her 2 brothers end up with nothing, or Suzie needs to figure out how to buy out her brothers – in order to do that, Suzie would have to come up with approximately $2,333,333 (2/3 of $3.5 million).
"Own it together" rarely works
Mildred’s first idea was that “all 3 of them can own it together”. In my experience, that seldom works. Few people are willing to wait years and years for their inheritance.
Buy outs rarely work
Mildred’s second idea was that “well, Suzie can just get a mortgage and buy her brothers out”. Frankly, that doesn’t work either – first of all, she’d need to qualify for a $2.3 million dollar loan … that works out to a loan payment of over $11,000 per month. If you assume that most lenders want at least a 2:1 or 3:1 ratio of salary to loan payment, that means Suzie would need to be earning at least $22,000 to $33,000 per month ($264,000 to $396,000 per year).
Let’s just make it clear that Suzie’s not earning anything close to that. And then there’s the income tax issue … only the first $1 million of a home mortgage is deductible on your income tax return.
Avoiding an estate plan that's bound to fail
A good estate planning lawyer won’t just blindly set up a plan that’s bound to fail. The solution depends on a number of factors, and each situation is unique. For example, in Mildred’s case she talked to the children. They all agreed that Suzie should be able to stay in the house, but that they did not want to wait “years” after their mother’s death for their inheritance. Because Mildred is relatively young and in good health, she qualified for a sizable life insurance policy. Since the “kids” are the ones who would benefit from the policy, they agreed to make the annual premium payments. They are also the owners of the policy, so Mildred is not using up any of her lifetime gifting exclusion.
This might not be the correct solution for everyone, but it worked well in this situation.
All the best,
