A recent paper from the Center for Retirement Research at Boston College examines retirees’ intentions for bequeathing their homes to heirs. For Retirement Director Ben Rizzuto, the research highlights the importance of having candid discussions about wealth transfer – particularly the non-financial issues that can complicate matters.

I grew up in Swink, CO. Where is Swink? Well, Swink is in southeast Colorado about three hours from Denver. It has zero stoplights, 700 people, and children in grades K-12 attend school in one complex.

Swink is a small town and I love the fact that I can say that I come from such a place. In fact, I continue to visit as my parents still live there, in the house I grew up in.

The authors make the point that retirees, by not utilizing the equity in their homes, may be depriving themselves of an important source of income in retirement. This highlights one reason why financial professionals should be interested in this paper and its implications for retirees. (But we’ll save that topic for another blog post.)

The findings I’d like to focus on now just happen to hit close to home for me (pun intended) because, to put it bluntly, I don’t want a house in Swink, CO. Don’t get me wrong, I would gladly accept any type of inheritance my parents are able to provide. But providing it in the form of a house in a town I probably won’t be moving to may complicate things.

The potential obstacles my own situation presents highlight the important financial and non-financial issues that need to be discussed with families and heirs. And it isn’t just the couple with millions of dollars in investable assets that needs to have these conversations – it is pretty much every couple. Remember, the paper highlighted couples who want to leave $10,000 or more as an inheritance. With the real estate market as it is, pretty much every house – even those in Swink – are worth far more than that.

The “Easy” Part: Financial Issues

That provides a good starting point to delve into the financial issues associated with real estate inheritances. My parents bought their house in the 1970s for something like $25,000. It is now worth several times that (approximately $125,000). This serves as a great example to discuss gifts versus inheritances.

Generally speaking, inheriting real estate will make better sense from a tax standpoint as you will receive a step-up in cost basis whereas if it is received as a gift during life you would receive it at its original purchase price.

In my case, if I inherited my parents’ house, my cost basis would be $125,000. But if they gave it to me as a lifetime gift rather than an inheritance, my cost basis would be $25,000. If I subsequently sold the house for $125,000, I could be looking at capital gains taxes on $0 (in the case of an inheritance) or $100,000 (in the case of a gift).

Alternatively, my parents could choose to sell the house and use the proceeds to supplement retirement income needs or fund their dreams of living abroad part time.

The Not-So-Easy Part: Non-Financial Issues

Depending on one’s needs and goals, the financial issues in these scenarios are fairly  black and white. Non-financial issues, on the other hand, are where things can get murky.

Even though I may not want a house in Swink, my parents do have to live somewhere. This brings up questions regarding care as they age. If they choose to stay in their home, we’ll need to figure out who will be available to provide care for them should they need it. If they choose to move into a retirement home, we’ll need to figure out what to do with the house. Selling it could provide assets to pay for a retirement home but, as we noted, that could lead to tax issues. So, if we choose to keep the house, we’ll then need to figure out how to handle its upkeep.

As you can see that little house in Swink creates a lot of questions that need to be discussed. The answers to those questions affect my parents, my family, my sister’s family … all of us. And it highlights how important family money meetings – ideally moderated by a financial professional who can offer objective insight – can be a forum to discuss these issues.

The conversation between couples and their financial professional should start with a couple’s bequeathing wishes. Whether it’s cash, stocks, property or a house, couples need to take an inventory of all the items that might be left to the next generation. Then it’s important to review these physical, financial and possibly even digital assets to discuss the couple’s wishes, goals and timelines for use, disposal or gifting. Once this has occurred, the next key step is to bring other family members into the conversation.

What’s on the Agenda?

Again, family money meetings are a great way to do this and financial professionals can help to orchestrate these events with all parties involved. Following are a few items that should be included on the agenda:

Reviewing the will is arguably the first and most critical exercise to be completed at the meeting. Taking the time to go over this document in detail allows parents to not only let children and family members know what they may or may not be receiving as an inheritance, but also to explain the reasoning behind these gifts. While this may not be an easy discussion to have, it is almost always preferable to heirs being left in the dark, only to be surprised or confused later by these decisions.

If parents are planning to leave a house to children, this may be a good time to discuss the implications of that gift for the parents as well as the recipient. For parents, it’s important to ensure a will provides clear directives on this front, and to include considerations regarding any estate tax liabilities.

Where more planning may be required is for the recipient. There are the issues of upkeep I mentioned above with my own situation, plus property taxes and whether there is any outstanding mortgage debt. That’s if the recipient plans to keep the house. If not, there could be costs associated with selling it, such as updating the home to make it ready for sale, as well as potential tax issues associated with that sale.

Of course, these are just the financial issues – there are also the non-financial issues, which again tend to be far more complex. There’s the time associated with all these activities, and that the house may be located in another town, city or state. And of course the emotional issues that are often associated with its disposal.

Parents and families need to consider all of the potential implications when thinking about these types of gifts. It’s not so much a question of what do you want to leave to your children, but rather what do you want to leave your children with?

The loss of a parent is a difficult time. And talking about that inevitable occurrence before it happens can be uncomfortable and emotional – which is why many families tend to avoid it altogether. But it’s important to think about how you can make it easier. So I encourage you to take the initiative early, arrange those family money meetings and carefully consider the implications of inheritance plans on everyone involved. I’ll soon be taking my own advice by booking a meeting with my parents to talk about that house in Swink.

 

¹Engelhardt, G. and Eriksen, M. “Intended Bequests and Housing Equity in Older Age.” Center for Retirement Research at Boston College, January 2021.