Some day the control of your buildings and your business will pass to others. This may be upon your retirement or death, or if you become incapable of managing your own affairs. You can let the default provisions of the law determine who will take control, or you can decide for yourself, through proper estate planning.
The principles discussed here apply to ownership of real estate and businesses such as corporations and partnerships. For convenience we will simply refer to “buildings” rather than "business" or “shares of stock”.
Who Gets the Building?
How to divide up the estate is an age-old concern. In many cultures, the oldest son inherits the farm…or the apartment building. In modern-day San Francisco, the property is often divided equally among the children.
When parents die, unresolved sibling issues often come to light, and the siblings may direct their anger at each other regardless of whether they own a building together. Co-ownership of apartment buildings after the death of the parents can be like putting fuel on the fire. Moreover, it is sometimes difficult to predict whether the children will have the skills required to be a competent building manager. A poor manager can ruin your otherwise successful investment in the building.
Estate planning means facing challenging questions. For example, do you want your building to be owned and managed by one or more of your heirs upon your death? What is the nature and extent of any current involvement of family members in the management of the building? Do you have any plans to involve family members in the management, and if so, how will those plans be implemented? What are the family dynamics, and what is the potential impact of those dynamics on the continuing success of your investment in the building? What is the current and anticipated involvement of the spouses of your family members, and what will be the impact of a family member’s divorce on the management of the building?
Some of the most difficult questions relate to your willingness to let go of the control of the building during your lifetime. What will be the effect of your withdrawal on the continuing success of your investment in the building? What is the likelihood that you will intervene in the management of the building after your withdrawal, and what will be the impact of that intervention, including potential conflict between family members managing the building?
In addition, it is important to elicit the views of your family members regarding their interest and willingness to take an active role in the management of the building, and then to determine whether those family members will be able to successfully perform the tasks required. These issues may affect your decisions regarding which assets to leave to which children.
Family meetings are a useful way to create a sense of ownership and involvement in the activities of the building, especially for family members receiving inactive interests in the building. Family meetings can also foster cooperation and team spirit.
Lifetime Transfers to Avoid Estate Tax
Without proper planning, much of your wealth may go to the U.S. Treasury upon your death.
Many people want to see their buildings stay in the family for some time after their death, rather than having the family sell the buildings to pay estate tax. There are several steps that can make this a reality. Transferring the property to family members during one’s lifetime, directly or through a grantor trust, is one way to keep your building in the family and avoid estate tax. There can be some tax costs associated with lifetime transfers, and they must be planned carefully, but they are an excellent way to keep the government from taxing the future appreciation of the buildings upon your death.
Life Insurance Trusts
Buildings often have to be sold after the owner’s death to pay the estate taxes when there is not enough money in the bank to pay the taxes. Setting up a life insurance trust, and then transferring ownership of your life insurance policies to that trust, can provide the family with enough liquidity to pay the taxes and keep the buildings in the family. Note, however, that half the life insurance proceeds will have to go to the government in the form of additional estate tax if the life insurance policy is not owned by the right kind of trust.
Protect Yourself From Other Creditors
Liability insurance that protects the building from tenants and other potential creditors is another aspect of planning that can help to keep the building in the family. Liability insurance can become very expensive, though, and insurance companies limit the amount you can buy. Another way to limit liability to creditors is to own each building in a separate, limited liability company.
Prenuptial and Postnuptial Agreements
Whatever is left after the government gets its share, and creditors are paid, can be divided up among your loved ones. This assumes that your marriage or domestic partnership ends in death and not in divorce. In the event of divorce, your spouse may have a “right of contribution” for the value of the services you provided in managing the building during the course of your marriage or domestic partnership, even if the building itself is your separate property. This is because your services are considered to be community in nature. You can provide clear agreement on these questions in a properly drafted prenuptial or postnuptial agreement.
Blended families with children, in which there have been previous marriages or domestic partnerships, have some of the most complicated estate planning concerns. Who will inherit premarital assets? Will it be the kids from the prior marriage, the current spouse, kids from the current marriage, or all of them together? A more complete analysis of these questions is necessary, but well beyond the scope of this brief article.
Frank Sinatra who died in 1993, provides a great example of how to avoid potential blended family pitfalls. A corporation he controlled owned his most valuable asset...the right to his name and likeness. He was well aware of the bitterness between his second wife, Barbara, and his kids from prior marriage to Nancy. This awareness did not stop him from leaving the valuable corporation to Barbara even though it was managed by his daughter, Christina Sinatra. Worried that his wishes might provoke a fight in probate court upon his death, Frank included a "no-contest" clause in his will. It spelled out that any family member who took adverse legal action upon his death would be completely disinherited, specifying thirteen different legal actions that would invoke this "no-contest" clause. While Sinatra's "no-contest" clause may have disappointed his children, it seems to have spared his family from an expensive, emotional and public court battle! Guide to Preventing Inheritance Feuds With a No-Contest Clause.
Co-ownership disputes are predictable when someone inherits a partial ownership interest in a property, and such disagreements are certainly not limited to buildings. In many cases, quarrels arise because someone who inherits a property also inherits a business partner they’ve never worked with or perhaps even met before. Problems ensue when the original owners have neglected to negotiate a legally-binding buy-sell agreement specifying who can sell their shares under what circumstances.
Here is an example from the world of professional sports to illustrate how co-owners can disagree about the actual financial value of their jointly-held property—and how this can dramatically impact their ability to sell their shares. In this case, sportsman and investor Franklin Mieuli owned a minority interest in the San Francisco 49ers football team from 1954 until his death in 2010. In 2011, some of his surviving heirs inherited a five percent stake in his minority interest and wanted to sell it. They discovered then that the franchise’s biggest shareholders, the York family, claimed the team’s financial value was much lower than other sources had calculated. Forbes magazine, for instance, reported the 49ers worth at about $990 million, but the Yorks insisted it was only about $360 million. Because that would drop the payment to Mieuli’s heirs from $49.5 million to $18 million if they sold their shares at that rate, they filed a lawsuit charging the Yorks with trying to cheat them out of millions of dollars by lowballing the franchise’s value.
This particular problem could have been avoided altogether if Franklin Mieuli had presented a proper buy-sell agreement to the other co-owners when he first purchased his minority interest in 1954. Such an agreement would have spelled out exactly how the team’s financial value would be determined using any of various fairly standard valuation methodologies. If the team’s co-owners had signed such an agreement, the valuation would have been fairly straightforward, and there would have been no need for Franklin Mieuli’s heirs to initiate litigation more than half a century later.
Whether the asset in question is a football team or a building, when more than one person is expected to inherit the asset, a buy-sell agreement can address how they are going to own it together. These agreements can be used to answer questions such as how to compensate the one owner responsible for overseeing the management of the property. A right of first refusal can be used to discourage or prevent one co-owner from selling, exchanging, or otherwise transferring an interest in the property. The price can be set so low, and the terms of purchase so favorable that, as a practical matter, no sale is likely to occur. Such rights of first refusal can be a powerful mechanism to prevent outsiders from acquiring interests in the property. You may also require that a number of individuals have to consent to the sale of the property. For example, if you leave the property to all of your children, you can require a unanimous or super-majority vote of the children before the property can be sold. These agreements are most effective when you and your family have carefully thought them through after full discussion. Your lifetime leadership can make all the difference for your grieving loved ones when you die. Guide to Buy-Sell Agreements in Your Estate Plan.
Keeping Your Buildings in Trust
Perhaps the most effective way to prevent the sale of your building is to provide that the building will remain in trust for a specified number of years after your death before it can be sold or distributed to your beneficiaries. The trust document can give the trustee greater discretion to retain the building than is allowed by the default provision of the statute. This means that the beneficiary would get the property later. The trustee’s potential liability for retaining assets is minimized when the trust document specifies the particular building or buildings to be retained and sets out the reasons for retention. For example, the trust document can specify that you, the settlor or creator of the trust, want to pass the building(s) to succeeding generations because you believe that the portfolio you have built will protect the beneficiaries better than any investments the trustee could make.
California law severely limits a trustee’s ability to operate a business or even lease property as a lessor in the absence of an express provision in the trust document. The drafting attorney should include specifically tailored provisions allowing the trustee to own and operate rental properties where appropriate.
One advantage of this approach is that the interests of the beneficiaries in the trust, or in the building, are protected from creditors of your beneficiaries. This means that even the former spouses of your kids cannot interfere with the trust. The trust document can also be drafted to prohibit the sale of the beneficiaries’ interests in the trust.
Who Do You Trust?
Most people act as their own trustees while they are alive to maintain control over their assets. They also may amend or revoke their trusts to remove any third party trustee with whom they are unhappy. After death, however, the choices of successor trustees usually become irrevocable.
One of the most important decisions you will make is who will serve as trustee of your trust. The trustee becomes the legal owner of the property. The trustee holds the authority, usually at the exclusion of the beneficiaries for whom they act, to implement and administer the trust according to its terms, and to decide when and if the property will be purchased, sold, exchanged, abandoned, or invested for high income, low income, or no income at all. The trustee also carries out the “who gets what” provisions, which, in many trusts, may include deciding when to make distributions and how much to distribute. The trustee is a fiduciary and must act in the best interests of the beneficiaries.
Who to choose as trustee depends upon the terms of the trust and the purpose for which it is created. The tax consequences of choosing a particular trustee must be given careful consideration.
When to Plan for Your Successor
Regardless of your age and health, now is the time to plan for your successor. Perhaps nothing will be more important for the continued financial success of your buildings than having that plan in place.
With proper planning, you can minimize the amount of your assets going to the government and maximize the amount going to your loved ones. The time and money you invest in creating a comprehensive estate plan can save your family big dollars and big headaches after you are gone.
© 2012 John E. O’Grady
The information contained in this article is general in nature and should not be relied upon for any specific situation. Consult a qualified attorney for any specific legal advice.