We often have clients who would like a child or other beneficiary to receive a specific asset.
To understand this situation, consider our friends Jack and Jill Smith. Jack and Jill have four children, Adam, Betsy, Carl, and David. Their total assets are $1M, and include a family cabin property worth $400K. Adam and his family use the cabin the most, and Jack and Jill would like to see him end up with it as part of their plan. What are their options?
Option 1: Specific Bequest
The first option is simply to give Adam the cabin, and divide all other assets equally among their children. This achieves their goal of making sure that Adam receives the cabin. However, it means that the total shares are:
Fair is not always equal, and equal is not always fair. There is no rule that says Jack and Jill need to treat their children equally. But Jack and Jill may think this is unfair, as may three (or, perhaps, four) of their children.
In addition, if they design the plan this way, they would need to specify what happens if the cabin is sold or if Adam predeceases them. This plan can also create issues if Jack and Jill need care at the end of their lives. If that care requires substantial assets, should the cabin be sold and the proceeds used for their care? Or should their other assets be used, diminishing the shares of their other children even further? What happens if Adam is their power of attorney and needs to make that decision?
In the end, this option accomplishes one goal (transferring the cabin to Adam) but may not be consistent with Jack and Jill’s conception of fairness, and can create problems in certain life situations.
Option 2: Equal Shares
The second option is to not specify anything with regard to the cabin, and simply leave their shares to their children equally. In that case, at the death of the surviving spouse, the administrator (with input from the four) would make a decision on whether to sell the cabin to a third party or do something else with it. That something else could be a sale/distribution to Adam, a distribution to the four (assuming they all want that) or a sale/distribution at value to a smaller group. (For a discussion of options for joint cabin ownership, see our cabin LLC article, found here.)
In the case of a sale/distribution to Adam or another beneficiary, this becomes a numbers game. If Adam is willing to purchase the property at $400K, he would need to apply his $250K share to the purchase and borrow or raise another $150K to complete the purchase. All shares are equal:
The key is working out the number for the cabin purchase. Typically this would be done by obtaining an appraisal, then negotiating from there. Often we see a 5-10 percent discount from appraised price for these types of transactions, since it is reasonable to expect that a market sale would incur commission (6%) and may be for slightly less than appraised value.
This option achieves fairness, if fairness to Jack and Jill means the shares for their children are equal. It also allows for flexibility and negotiation regarding who will receive the cabin and at what price. This can be a good or bad thing depending on Jack and Jill’s perspective. On one side, flexibility ensures that whoever wants the cabin most and is willing to back that up with capital will receive it. However, handled poorly it can lead to a difficult or even adversarial negotiation. If Jack and Jill’s goal is to ensure that Adam receives the cabin, this is an unnecessarily difficult way to get there.
Option 3: Option to purchase
A final way to handle this situation is the use of an option to purchase. The way this works is that Jack and Jill’s will specifies that Adam has the option to receive the cabin at a set price, typically 90% of appraised value on the surviving spouse’s date of death. In that case, the numbers work out as with option 2 above: Adam can apply his share to the purchase price, but must borrow or raise another $150K to close the transaction. All beneficiaries are treated equally.
This solution is the one our clients choose most often. It avoids a difficult negotiation over who will receive the cabin or at what price. Those terms are supplied by the document. However, it still provides some flexibility (if Adam’s circumstances change, he can decline and allow the property to be sold). Often most importantly from the parents’ perspective, it allows all children to be treated equally.
Option 4: Current Sale/Transfer
A final way to handle this situation is by transferring the property now rather than at death. This can be a sale for value, a partial sale/partial gift, or a gift. So, for example, Jack and Jill may sell Adam the cabin now for $300K rather than the $400K they might get from someone else. This has some advantages—Jack and Jill can be done paying property taxes, and Adam can use and improve the property as he sees fit. However, the gift will make Jack and Jill ineligible for public assistance for five years from the date of the gift and may have adverse tax consequences for Adam if he ever does sell. It also does potentially treat Adam differently from the other children, although this can be adjusted for with a cash gift to the others or an additional estate gift.
Are you considering a gift of specific property as part of your estate plan? Contact us to set up a no-obligation estate planning consultation.