The Plan Was to “Will It” to the Kids – A Case Study
People like and appreciate stories. I like stories. I like telling stories even more. Because of this, I will be periodically sharing actual exchange cases in story-like format to help illustrate the power and different nuances of the exchange. The names have been changed to protect privacy.
The following story highlights the common story of how a family believes they are going to will an asset to their children when, after further review, they realize that there are better plans not only for the present day but also for the future as well as the financial implications to the future for the children.
“We are just going to pass it on to the kids” – a common reply from parents
A couple in their early 70s owned an apartment building in Arizona that they had owned for more than 25 years. They owned it free & clear, and they had three kids. The plan was always to will it to the kids. The wife had fallen ill and had racked up more than $150,000 in medical bills which subsequently exhausted the couple’s cash position having to bleed dry, pretty much all of their holdings and savings to keep up.
Because they had been in regular content with their financial planner, the financial planner realized that it would be just a short amount of time before they would no longer have any cash. The only real asset left was their apartment complex, and the financial planner realized that there was significant equity it could be tapped into. What he didn’t realize or consider was, which was better; to take a loan out on the property or sell the property? This is when the financial planner reached out to me to consult with the family.
An exchange was probably the best strategy to give them peace of mind.
Taking a loan out on the property didn’t make much sense because the property already had significant deferred maintenance that had compiled over years of neglect as the parents got older and we’re living off the income, not putting reserves aside, which meant selling and completing an exchange was probably the best strategy to give them the peace of mind and the cash they needed.
When looking at selling the property, the financial planner reached out to the family CPA to find out what the capital gains tax implication might be. It was determined that the property was worth close to $13 million. The family had originally bought the asset for three million, so they were looking at a gain of more than $10 million which would come with a capital gains tax of more than $4 million. When the CPA consulted the kids, they all agreed that it would make more sense to sell and exchange.
The more planning that is completed with all financial advisors, the better!
It was determined after much consultation and conversation, that the best plan of action would be to sell the property, have the parents take out $1 million in boot, and exchange with the remaining $12 million, which would allow them to purchase three separate properties at $4 million each, one for each child.
My plan of action was to first sit with the children to discuss their options and then each separately as they decided which type of property that they would want to exchange into and ultimately inherit once the parents passed. The two eldest children chose their own net leased assets and the youngest chose a self-storage asset, as he had experience in that industry.
The parents ended up with enough cash from the boot to pay all the past and current medical bills, and all of their remaining debt. The income from the assets provided an increase in their overall annual net income and the succession plan would be smooth for the kids rather than trying to decide how they would handle splitting the apartment asset three different ways. I was also able to advise the kids how once the parents did pass, that there were strategies we could employ that would allow them to enjoy a steady income and ultimately pass their parents legacy on to their children.
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All information is deemed to be accurate, and not advice. All investors/taxpayers should consult their CPA, tax attorney and investment advisors.