Abstract

Many of our clients will leave an asset like a residence or summer cottage to their children or inherit one from their parents. Sometimes tensions build as one child may wish to keep it in the family, or reside in it themselves, while others, perhaps who have moved far away, will want to sell it. The following process walks a family through the steps necessary for treating all involved fairly – and, even, better off.

How to transfer a house among three family members.

There are three simple steps to this process:

•  Agree upon a price
•  Agree upon a financing strategy
• Transfer the property

How to agree upon a sale price

 When parents die and leave a house equally to their children, each may have a differing opinion on the value, depending on whether one wants to sell it or one wants to buy it. Remember the adage: “Where you stand, depends on where you sit. ” The best way to determine a value is to put it up for sale. Transferring within the family means creating an artificial market for the property. And yet, this may actually lead to a better outcome all around.

1.      The first step in reaching a resolution is to agree on ground rules.

a.     Discuss what each person wants to do with the property.

b.     Agree on what each beneficiary’s percentage of ownership is.

c.      Agree on how decisions will be made: on headcounts, percentage of ownership, trustee decisions only, or some combination.

d.  Develop a timeline.

2.     Decide whether to pay outstanding debts before setting the price for the house or deducting them from the price of the house.Whatever you decide, do not allow bills to become late as you do not want encumbrances to obstruct the transfer.

a.     Is there a mortgage?

b.     Are there taxes due?

c.      What about deferred maintenance?

3.     Arrange for a home inspection. Later, you will have to hire an independent valuator (appraiser); don’t confuse the two. Hire a home inspector to uncover defects in the home such as mold, dry rot, or cracks in the foundation. You would not be able to sell the house on the open market -- a public sale -- without disclosing these defects and you should not either sell or buy it in a private sale without full disclosure either.

a.     If there is a defect, determine how much it will cost to repair it.

b.     Either repair it up front or disclose the cost of remediation to the appraiser.

4.     Next, separately consider the value of the contents. Agree on what stays, what gets tossed, and what gets distributed -- who gets what -- before proceeding with the transfer of the house. Eat one “Frog” at a time, as Brian Tracy would say.

a.     Take turns selecting furniture or collectibles, flip a coin to decide who gets to choose first.

b.     If one item clearly is more expensive than the rest, agree to:

        i.     Sell it.

      ii.     If one or more of the beneficiaries want that item, then value it, and give the other beneficiaries the chance to select multiple items to offset the value.

     iii.     Use the sale of the house to provide cash to equalize that item.

c.      Agree what to do about items that were there when the original house was purchased. Should these remain as part of the house and its sale price? After all, they were part of the original sale price.

d.     Items that no one wants must be removed before transferring the house. The cost of this removal should come out of the sale price and be borne by all – or at least this should be an item for discussion, and maybe given as a credit to the buyer.

5.     Agree to credit the buyer for some percentage of what otherwise would have been a reduction in the net proceeds due to transfer taxes and real estate commissions. Discuss how to share this windfall prior to agreeing to a price.

a.     Real estate commissions can reduce the net income to the seller by as much as 6% of the sale price.

b.     State and local transfer taxes can further reduce the net to the seller. Usually, the county collects the tax. Counties in Pennsylvania collect 2% of the agreed upon sales price, including the value of as yet completed improvements required that were included in the sales contract.

c.      Make sure to specify this was an internal family sale on the deed.

6.     Hire an independent appraiser who knows the local area. Part of their training includes understanding the nuances that shape prices. Here are some of the points they must consider:  

a.     The exact house located elsewhere may differ wildly in price. Although you must not interfere with the independence of the valuation, you should watch what locations are used to compile the list of recent sales. Make sure the appraiser accounts for the differences in the communities.

b.     You may hear opinions from a local realtor as to the potential price, but be careful because a realtor has an incentive to overstate the price to get you to list with them. They know the area but they make their money from public, not private, sales.

c.      The expense of property taxes, condo fees, and assessments will alter the value of a house. Smaller vacation communities may have higher expenses per household, which an appraiser would take into account when comparing recent sales.

d.     If you are going to fix up the house, do it before hiring the appraiser. The appraiser cannot produce an objective report if required to imagine what a new kitchen will look like, or whether a fresh coat of paint will enhance the curb appeal.

                                                    i.     You will have to make certain repairs to keep the house from deteriorating.

                                                  ii.     Nevertheless, rarely does spending a dollar to improve a house result in an increase in value by that same dollar. Outside of basic structural repairs, you are better off selling it at a lower price rather than throwing money at it hoping to raise the sale price.

                                                iii.     Even if you could raise the sale price by the same dollar, in a public sale, the realtor fee and transfer tax will eat away at the increase in value. Invest your money or improve the house you live in; don’t improve a house you will turn around and sell.

7.     The seventh step is to agree upon the price. The only way to know what the market will bear is to sell it; short of that, you should have the information you need now to negotiate a price among the heirs. Did you know that new issues of bonds can either be auctioned off or negotiated, just like this discussion describes transferring real estate?

a.     The appraisal is just one input into the process. If you agree in advance to accept the appraisal as a starting point, then you would add or subtract the other factors, such as remediation, furnishings, and transaction costs.

b.     Draw up a Memorandum of Understanding on the price immediately and have all parties sign and date it. Make sure everyone has a clear understanding of what was agreed. Do not let the agreement exist in memory only.

8.     Agree on a financing method.

a.     Lump sum – the buyer agrees to pay cash to each of the other owners (but sometimes the buyer does not have the means to pay cash).

b.     Shares of estate – the buyer agrees to relinquish other assets when they come available to the other owners. This is especially true when there are other high priced items, such as additional real estate.

c.      Outside mortgage – the buyer will take the agreement of sale to a commercial lender who will then provide a check to buy out the other owners.

d.     A private mortgage – The sellers agree to finance the sale to the buyer with a right to reclaim the property if the buyer reneges on her obligation. Sellers may also hold a lien against the property or other properties in case of the death of the buyer, while allowing the estate of the buyer time to pay the outstanding balance. Buyer and seller agree to follow an amortization schedule based on term, interest rate, and payment frequency as well as allow or not allow a prepayment of the remaining principal.

9.     Transfer the deed. Normally, when a person sells a property, she must assure the new owners that she has sole legal right to the property. Not only does she hire a company to search to see if there are any liens against the title, but she would have to post a bond to assure that no such liability or other claims exist. All this requires additional expenses. However, when family members transfer their interest in a property to another family member, the only thing they need is sign a “Quitclaim Deed.”

a.     A quitclaim deed acknowledges that although the grantors have a legal claim to the property, they are releasing the claim to allow one owner to have sole discretion over the property.

b.     This takes the other heirs off the hook in case of a future liability against the property.

c.      You can request a copy of the current deed from the register of deeds to see how to word the quitclaim deed.

d.     You can obtain a quitclaim deed form from an attorney or search for one online. This simple document includes: the names of the current owners and future owners, the property description, including the municipality (information contained on the deed), notarized signature of the grantors, and the precise address of the grantee. Make sure to state that the transfer is between siblings to avoid the transfer tax.

e.     You would mail this form to the Register of Deeds of the county in which the property is located, along with a filing fee you can find at the website for the county.

That really is all there is to it. If you follow this step by step process, you will get the task done with the same or less money spent than if you sell it on the open market. The buyer will get the house for less than what they would spend on buying a similar property and the sellers will get more than if they sold it through the public process. Most importantly, they will transfer the property without alienating the very people they want to spend Thanksgiving with, perhaps at the next generation’s get away house.