Inheriting property from a home trust—whether it’s from a parent or other benefactor—can be a fortunate but complex situation. It’s likely that someone close to you has passed away, so emotional distress could cloud your judgment and inhibit you from making a clear-headed decision about what to do with the property. Plus, if multiple people inherit the home, things can get very tricky on both a financial and personal level.
If you and your co-beneficiaries decide one person is going to keep the home and buy the others out, it’s important to take the proper actions so you don’t end up paying for missteps down the road. So how does one person go about buying out the other beneficiaries? It’s a bit more complicated than you might think.
How a home trust can get complicated
The ideal scenario is when everyone agrees that one beneficiary will buy out the other(s). But things get touchy when everyone has different ideas about what they want to do with the property. If there are more than two beneficiaries, then it gets even more complicated. One person might have an emotional attachment to the property but not enough funds to buy the other parties out. Another person might want to keep the property as a long-term investment, while others may want to just sell it and cash out immediately.
How to buy out another beneficiary
If the parties involved agree that one will buy the others out, O’Hare says, it’s important that the transaction be treated as an “arm’s-length transaction,” which means the property needs to be sold for fair market value and emotions need to be put aside. Even though you’re dealing with family or friends, you want to make sure you conduct business like business.
Get an appraisal on the property, or at least a real estate agent’s opinion of the value. Both or all parties should retain real estate agents who can represent their interest in the transaction and draw up a purchase and sale agreement so there are no misunderstandings.
Missteps
Some beneficiaries—usually congenial family members or close friends—are fine with being bought out at a reduced rate. However, you don’t want to be too nice and sell the property at a price that’s too low, because it could mean big tax issues down the road.
When the property is sold at a discount, if the owner ever wants to sell the property in the future, O’Hare says, the following situations could turn into issues:
Not being able to claim as much depreciation on the property that you might have been entitled to if it were purchased at fair market value.
Worrying about a higher capital gains tax, which is calculated on the selling price less your adjusted basis (which is the purchase price less accumulated depreciation).
Not hiring professionals like real estate agents, an appraiser, and a mediator out of the gate is another mistake people make.
“In any transaction that involves a trust, you need to make sure you are consulting with competent professionals that can advise you,” says O’Hare. “You’re better off to pay the professionals now than to have to pay the professionals and the IRS later.”