Navigating the Complexities of Bequeathing Real Estate to Children

Turning Personal Residences into Investment Properties Essential FAQ Guide

Introduction

Estate planning is a crucial aspect of financial management, especially when it involves significant assets like real estate. While it’s a common desire among parents to pass on their property to their children, the process is often fraught with complexities and potential conflicts. 

Dealing with Taxes and Family Dynamics

When you sell real estate that has appreciated in value, you are typically liable for capital gains tax on the difference between the selling price and the original purchase price, adjusted for any improvements made. If you wait and bequeath property to your children upon your death, they often receive a “step-up in basis.” This means the property’s tax basis is adjusted to its market value at the time of your death. Consequently, if your children sell the property later, they may pay significantly less in capital gains tax, as their taxable gain would be calculated based on the value at the time of inheritance, not the original purchase price.

However, deciding whether to divide assets equally among children or based on their individual needs (equitable distribution) can be challenging. Equal distribution is straightforward but may not always be fair, especially if one child has been more involved in managing the property or has a greater financial need. Real estate often carries sentimental value, which can lead to emotional conflicts among siblings. Clear communication and possibly the involvement of a family mediator can be crucial in addressing these issues.

If the property is an income-generating asset, like a rental property, consider the children’s ability and willingness to manage it. If not all heirs are interested or capable, this can lead to disputes or mismanagement. Siblings also may have differing cash flows needs. Some may prefer to sell for a lump sum payment and others may prefer the monthly cash flow.

DST Strategy for Smoother Transition

A Delaware Statutory Trust (DST) allows for the ownership of a fractional interest in a large, diversified portfolio of real estate properties, which can reduce risk compared to owning a single piece of real estate. The properties within a DST are professionally managed, eliminating the need for your children to manage the property themselves. This is particularly beneficial if they are not experienced in real estate management.

Transferring interests in a DST can be simpler and more cost-effective than transferring real estate directly. It avoids the complexities of real estate transactions, such as property inspections, appraisals, and title searches. When used as part of estate planning, a DST can offer tax advantages. For example, the beneficiaries may receive a step-up in basis upon the death of the donor, potentially reducing capital gains tax if the property is sold later.

As a trust, a DST provides limited liability protection to its beneficiaries. This means that their personal assets are generally protected from any liabilities associated with the properties held within the DST.

While real estate is typically a less liquid asset, DST interests may be more liquid, offering the potential for easier exit strategies for the beneficiaries. If the DST properties generate rental income, this can provide a steady income stream to the beneficiaries, which is not always the case with a single piece of real estate.

A DST can be structured to align with specific estate planning goals, offering more flexibility in how the assets are distributed and managed after the donor’s passing.

Conclusion

For parents looking to pass on wealth to their children, a Delaware Statutory Trust offers a sophisticated alternative to traditional real estate gifting. Its benefits in diversification, management ease, tax efficiency, and flexibility make it a compelling option for modern estate planning. As with any investment decision, thorough research and professional advice are key to making the best choice for your family’s future.

Unlock easiness in estate planning! Explore how a Delaware Statutory Trust can simplify property transfer. Start now!

Voss Real Estate Advisors

January 19, 2024

DST

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