How do you divide inherited real estate?

How do you divide up inherited real estate? This type of scenario can arise in a couple of different ways:

  1. It could be because you are doing estate planning and you want to tackle the question of what to do with the real estate head-on.
  2. It could be because someone who owned real estate passed away, leaving it to multiple heirs or beneficiaries. What if they have competing interests or different ideas about what to do with the property? That could create some problems.

There are several strategies to apportioning or dividing inherited real estate interests.

First, know that the inherited real estate can be sold and the proceeds divided. When the sale transaction is completed, the division of proceeds of the sale is very easy to do at the closing. Of course, factors such as the condition of the property, market conditions, and the economy as a whole can impact the sale.

If there are extensive real estate holdings, such as a large tract of land or multiple units that could be occupied or rented, then the real estate could be subdivided so that each heir would get a portion of the total portfolio.

Another option is for the heirs to continue to hold the real estate, and to apportion the income and expenses among themselves. This approach may make sense when the inherited real estate would produce a meaningful level of passive income.

Similarly, as in the case with a family vacation home, it may make sense for the heirs to continue to hold the real estate, and to apportion the use and upkeep of the property among themselves, as opposed to potential rental income.

Sometimes, however, one or more heirs wants to keep the property while others want to sell it. In that case, those who want to retain ownership can potentially buy the interest of those who want to sell.

If you find yourself addressing any of these scenarios, sign up for a strategy session with Windy City Legal and we can talk through the implications of each potential approach.

The Unintended Consequences of Holding Real Estate in Joint Tenancy

Marsha knew she wanted to leave her house to her only son. She didn’t want anything too complicated.  Then she had what seemed like a good idea: If she put a property in joint tenancy with her son, perhaps both of them might be able to avoid issues with probate later on.

Life was smooth for a while, but as the years went by, the relationship between Marsha and her son deteriorated. Now she wants to sever the joint tenancy, but finds that it is harder to do than she expected.

What is Joint Tenancy?

Joint tenancy is a form of co-ownership where multiple people own an undivided share of an asset and its attendant responsibilities. Each person has the right to use it. The last person left alive becomes the owner of the asset.

In this example, when Marsha passes away, her son will own the property outright. If her son passes first, Marsha will own the property outright. There will be no probate proceeding at that time. The ease of transfer to the surviving tenant usually is viewed as a positive benefit.

Things in life can change, however, whether due to family dynamics, financial considerations, business pressures, or something unexpected. Suddenly, the joint tenancy potentially can become an impediment. For example, if one party wants to sell the property and another wants to keep it, the joint tenants need to reach an agreement over what to do. Disagreement among joint owners can lead to disputes, soured relations, and even litigation to partition – or divide up – the ownership interests. Similarly, one cannot readily change or reverse the joint tenancy without agreement.

Another problem is that most joint tenancies do not provide protection against creditors of one of the joint tenants. (There is an exception for a marital residence held in a type of joint tenancy called tenancy by the entirety) If one of the joint owners has debts, at least some of the jointly-held assets may be utilized to satisfy those debts.

Other Pathways

Fortunately, there are other alternatives to joint tenancy. Marsha, for example, had other options to make sure that her son received the property without the need for probate after she passed away, while preserving her rights to potentially modify or to sell the property if necessary.

She could have set up an appropriate kind of trust. In the case of real estate, she could also set up a land trust, or she could have recorded a transfer on death instrument. Each of these options would have avoided the need for probate of the real estate, and, if set up appropriately, would have had mechanisms to allow her to make changes during her lifetime. The respective benefits of these options is outside the scope of this post – but is within the scope of estate planning.

If you’re considering a joint tenancy for real estate or other investments, talk to us first. Setting up the right plan can minimize the risks and unintended consequences that can impact you in years to come. Call us today at 312-278-1187 to schedule a strategy session.

What is a real estate tax proration and how is it calculated?

When buying or selling real estate, it is common to prorate real estate taxes. Ultimately, the purpose of the tax proration is to achieve a fair balance of the interests of purchasers and sellers in transactions.

Many counties in the region, including Cook County, collect property taxes. These taxes are then distributed to municipalities, park districts, schools, and other public services.

In Cook County, property taxes are billed twice a year, with an expected due date of March 1 for the first installment, and August 1 for the second installment. Just like income taxes, property taxes run a year in arrears, so the taxes that accrued in 2017 are paid in 2018.

In the first year after closing, the owner (who recently completed the purchase) will receive a tax bill for a period of time when the Seller owned the property. The tax proration is a way for the Seller to credit the Purchaser for the amount of taxes expected to be billed. The Purchaser is responsible for paying the tax bill when it comes due, but the Seller provides funds at closing with which to do so.

For Sellers, it is a way to account for obligations that arose during their period of ownership.

A traditional formula for calculating the tax proration is to take the product of (a) the amount of the last full-year tax bill, (b) the portion of the year(s) in which Seller was in possession of the property for which taxes are unpaid or yet to be billed, and (c) sometimes, a multiplier that accounts for possible tax increases.

This will result in the amount that the Seller should credit to the Purchaser at closing, which will appear on the settlement statements and closing disclosures.

What is a 1031 Exchange?

Section 1031 of the Internal Revenue Code allows capital gains taxes to be deferred rather than realized when selling investment properties and properties used in a trade or business. Generally, the production of business or rental income is a hallmark of investment property or property used in a trade or business, as opposed to property held for personal use.

Section 1031 does not apply to property held for personal use. Therefore, it does not apply to the sale of a principal residence.

To qualify, the property being sold must be replaced by another “like-kind” property, and the transaction must be structured as an exchange and completed within a certain period of time. Possible replacement properties must be identified within 45 days, and the acquisition of the replacement property closed within 180 days.

How can this help?

By deferring the realization of capital gains, the 1031 exchange may afford the owner greater purchasing power for the acquisition-side of the transaction. In contrast, in a non-1031 transaction, the proceeds of the first sale would be received and subject to tax. Then, the second transaction would be made from the remaining proceeds.

Maximizing the benefit of the tax deferment generally requires that the acquired asset be worth more than the exchanged asset, and that the proceeds of the sale of the first parcel be used in the acquisition of the second parcel and not withdrawn, and that all other applicable rules be observed.

What is a step up in basis?

Sometimes people want to sell part or all of an inheritance. Fortunately, they may benefit from a step up in basis.

The “basis” of property is the value it had when you acquired it. If the property appreciates in value over time, the difference in the value from when you acquired it to the time when you sell or dispose of it is the amount of the gain, upon which you may have to pay capital gains tax.

Property that was owned by a decedent when he died, and inherited by a beneficiary, is eligible for a step up in basis. The basis for the beneficiary is measured from the fair market value at the time of the decedent’s death. If the beneficiary sells an inherited asset, any capital gains would be measured from the value at the prior owner’s death, not from the time the deceased owner first acquired the property.

This matters because the beneficiary usually will be able to sell the assets quickly without creating a large tax burden, and because a step up in basis often greatly reduces the tax that would be owed.

The step up in basis can be a tremendous value to heirs and beneficiaries who inherit real estate or certain financial assets that had grown substantially over the years or decades since they were first acquired. If contemplating whether to transfer assets while alive or through an estate plan, it can be a factor that preserves significant value.

Five ways a real estate attorney helps Sellers get to closing

1. The contract
Whether you receive one offer or many, your attorney can help you interpret the strength of the offers. Also, since Buyers write up the offers, sometimes they include errors or unreasonable terms. We will find them before they become problematic. Need a special provision that the offer did not address? We can take care of that too.

2. Issues raised by the Buyer
What is the real reason that a Buyer is asking for a particular term or extension of time? Is it incidental and likely to go away shortly, or does it signal a potential problem that will cause the closing to drag out for months or potentially fall apart? We can help you understand Buyer requests as they arise.

3. Disclosures and documents required of sellers
All Sellers will have to make some disclosures, but which ones apply depend on the location, age, and type of property being sold. We can tell you which are required, and can assist in obtaining water, zoning, municipal, and condominium documents and certifications where required, to minimize the amount of bureaucracy that you have to attend to.

4. Advise you on any underlying problems with the property
Sometimes there are underlying issues with properties, such as an unpaid tax bill or other lien. We can help you assess such matters and work with you to clear them as quickly as possible, so that they are out of the way for closing.

5. Prepare the documents required for you to close
The list of documents to transfer the property to the Buyers is lengthy, especially if the property is held by a trust, LLC, or an estate. Fortunately, we make it as easy as possible to get through any of these scenarios, and complete the sale.

Five ways a real estate attorney helps Buyers before closing

1. Tailoring the contract
The contract needs to be accurate and should address the Buyers’ needs. Mistakes in the timing of deadlines, loan terms, or other provisions can cause problems. Inappropriate tax prorations can inadvertently shortchange Buyers. A careful review can prevent these types of pitfalls.

2. Deadlines
Buyers have a lot to do to get ready for closing. There is an inspection of the property, one or more deadlines for mortgage applications, and timing for review of any condominium or homeowner association disclosures. A real estate attorney will monitor the deadlines relevant to the transaction, and make sure the Buyers are informed of the steps to take and the timing to meet them. This can alleviate the stress of the transaction so that Buyers can focus on preparing for closing, arranging the move, and maintaining their professional and personal lives.

3. What to look for in HOA disclosures
The concept of condominium and homeowner associations is that the association as a whole provides more than what would be available to the unit owners individually for a comparable price. Buyers need to make sure that this will be true for the unit they intend to purchase, and that the rules of the association are compatible for how the Buyers intend to use the property. A real estate attorney can assist the Buyers in reading and understanding the association disclosures, so that they can make their determination with confidence.

4. Check for underlying legal problems with the property
Most of the time, Buyers do not want to take on pre-existing legal problems with the property. To the extent that code violations, title problems, and unpaid taxes can be uncovered early in the transaction, they can be dealt with, or if insurmountable, the transaction brought to a quick conclusion without wasting time and resources.

5. Lending
Not all mortgage loans are the same. Not all lenders are alike, either in terms of the types of loans or their risk tolerance. When Buyers need financing, their experience with the loan application process will often depend on whether their type of transaction is a good fit for their lender. A real estate attorney often can assist Buyers in identifying suitable lenders – thereby providing a smoother path to closing.

Putting residential real estate in trust

Placing residential real estate into a trust can sometimes be advantageous. Owning real estate in that fashion can avoid probate, and provide some asset protection benefits to the beneficiaries.

Covenants restricting transfer are ubiquitous in mortgages, however.

A provision in a federal law called the Garn-St. Germain Act exempts transfers of residential real estate of less than five units to a revocable trust where the borrower is a beneficiary and the transfer does not change the occupancy of the property. This allows such a transfer (subject to certain limitations) for estate planning purposes, without affecting the loan or triggering a due-on-sale clause.

It should be noted that the exemption does not allow transfers to irrevocable trusts or limited liability companies (LLCs). Those would change the ownership of the real estate, and would be in conflict with the lender’s secured interest in the real estate.

To proceed, the transfer should be advantageous to the grantors and trust beneficiaries from an estate planning perspective.

There are some other considerations as well, including municipal certifications and administrative costs to such a transfer, compliance with any homeowner or condominium association requirements, and insurance ramifications.

Landowners should consult their attorney to determine whether such a transfer is appropriate for their situation, and to ensure compliance with the exemption.

Six Ways to Protect Your House

For many families, the home is not just the center of daily life and a source of stability, it also represents the family’s biggest asset. That means it is worth protecting! Here are six ways to do so.

1. Estate planning.
Estate planning is essential to preserving value when you own real estate. When an Illinois property owner dies, the real estate passes through probate, unless other arrangements have been made in advance. When doing estate planning, these arrangements are customized to take care of the needs of the family. One common tool is a trust, which can address issues such as the care of young children, how to address split families that resulted from divorce, persons who are not responsible to manage the real estate or money, and any other concerns unique to the family.

2. Disability insurance.
According to the U.S. Social Security Administration, 1 in 4 people will become disabled before reaching retirement age. Disability insurance is a way to offset this risk, and ensure at least adequate income to cover expenses in the event a disability diminishes or eliminates the ability to earn an income. According to the Council for Disability Awareness, the average length of a disability is more than two and a half years. For many people without disability coverage, that is long enough to create a severe financial strain.

3. Life insurance.
Many young families require income from both spouses in order to pay the mortgage and monthly bills and expenses. In the event a covered person should pass, life insurance can prevent the tragedy from compounding into a foreclosure or bankruptcy situation for the survivor. There are multiple kinds of life insurance, which have different features and cost structures.

4. Property insurance.
Homeowners insurance protects the property owner from unexpected costs to recover from damage or destruction of the residence. How much would it cost to replace everything in case the home is destroyed? Consider that you may have to rebuild the entire house: walls, kitchen and bath fixtures, HVAC units, flooring, window treatments, furnishings, personal property, etc. Also consider the amount you will need for loss of use of the home for a period of time, to cover the cost of lodging and meals elsewhere. Policy terms vary widely, however, so it is important to review homeowner policies carefully to verify that they cover all relevant perils adequately.

5. Flood insurance.
A flood is defined as: “A general and temporary condition of partial or complete inundation of 2 or more acres of normally dry land area or of 2 or more properties (at least 1 of which is the policyholder’s property) from: (1) Overflow of inland or tidal waters; (2) Unusual and rapid accumulation or runoff of surface waters from any source; or (3) Mudflow; or (4) Collapse or subsidence of land along the shore of a lake or similar body of water…” In the insurance arena, there are technical differences between terms such as flood, water backup, and rain. Flood insurance is sold separately, and not covered by homeowner policies.

6. Umbrella policy.
An umbrella policy provides additional coverage against liability claims beyond the home or auto policy limits. In the event of an accident or other damage, umbrella coverage may provide a source of recovery to the injured party. If sufficient to compensate for any damages, the umbrella essentially shields the policy owner’s assets from claims by the injured party.

Recovering prepaid assessments, taxes, and rents

Recently, Bob sold his condominium. He had paid the homeowner association the full monthly assessment, and was concerned about what would happen since the sale was closing early in the month.

In real estate transactions, it is not unusual for the Seller to have prepaid certain assessments or expenses, or to have collected rents on leased property. How such costs and expenses get recovered or apportioned is one of the most frequently asked questions when closing draws near.

Unless the closing is scheduled for the first or last day of the month, a portion of these monies or expenses may be attributable to the other party.

Similarly, because property taxes are paid a year in arrears, the Seller will have accrued property taxes during his period of ownership that have not yet been billed. These taxes ultimately will be paid by the buyer when future tax bills come due.

Rents, taxes, costs and expenses can all be split, or prorated, according to the days of ownership. At closing, the party that did or will pay the expense receives a credit from the other. That way, each party essentially bears the costs attributable to its period of ownership.

When the proration is done at closing, neither side will have to separately collect an amount from the other. Instead, it is included in the amounts the Buyer needs to pay, or the Seller will receive, at closing.