The greatest transfer of wealth in American history is underway.
According to this Boston College study, from 2007 to 2061, $59 trillion will be transferred from American estates. This brings up an awkward but important issue facing beneficiaries: transferring ownership of real estate assets and what to do with them.
Beneficiaries need to take a few important steps in order to prove ownership. The most important of these is to obtain a clear title.
To obtain a clear title in Texas most estates will be required to participate in the probate process. Probate is required with or without a will. Probate is simply the process used by the courts to transfer title of assets from the deceased to their beneficiaries. To better explain this let’s look at a typical title transfer. If a house is in your name and you want to transfer the title (via sale or otherwise) you’ll sign a deed transferring ownership from you to the new owner. Since the deceased are unable to sign, the probate court is the only institution available to sign for them. There are situations when probate isn’t required but they are the exception. An example would be if the deceased left no will and the assets are worth <$50,000. In this case a simple affidavit will suffice. You may want to consult a probate attorney to help assist in the legal proceedings.
The probate process can be broken into 3 steps
Step 1: Appraisal of the estate’s assets
Step 2: Payment of any bills or debts, including the estate expenses
Step 3: Division of the estate according to either the will or state laws
Here is short video that explains the probate process in Texas.
Now that clear title has been obtained, the real decisions need to be made. Do you want to keep the house or sell it? Let’s examine the pros and cons of each of these decisions.
You’ve made the choice to keep it but what are you going to do with it? Major maintenance issues could arise in the absence of occupants. Delaying here can result in major expenses down the road.
Rent it. Renting a house can be a strategy to build wealth or a strategy to destroy it. It seems easy right, getting a house ready to rent. But depending on the condition of the home it could be costly. For example I bought an inherited house in Austin that had been vacant for over 2 years and hadn’t been updated since it was built. Needless to say the new owner (beneficiary) couldn’t just clean it out and get a tenant. In fact my partner and I spent $35,000 on the rehab prior to selling it. Most Americans don’t have $35k laying around to renovate a house. What if the beneficiary had decided to only put in $20,000 for rehab to get it ready for the rental market (our estimation)? Now let’s consider the costs of home ownership including taxes and insurance. And the hidden costs of vacancy and ongoing maintenance. And lastly a property manager. Let’s see these costs broken out for a property appraised at $150,000 with market rent potential of $1500/month.
Property tax – assuming 2.25%: $281/month
Insurance – assuming 1%: $125/month
Vacancy – assuming one month/year: $125/month
Maintenance – assuming 1% of value/year: $125/month
Property management – assuming 10% of rent/month: $150/month
Total expenses = $806/month
With rent of $1500/month you’ll be cash flowing $694/month, which is pretty good. But if you invest $20k then it will take almost 2 ½ years to break even. Most people don’t want to wait 2 years just to break even on an investment that large.
Depending on the location of the house, keeping it as a short term rental might make sense. But keep in mind that you’ll either have to maintain the property yourself or hire a property manager. If you’re going to manage it then plan on cleaning, doing laundry and restocking small items several times a month. Or you could hire a property manager but that will cost up to 40% of your monthly revenue. Also, keep in mind the legal implications of using your home as a short term rental. Check your local regulations.
The city of Austin requires owners to apply for a license prior to using their home as a short term rental.
Move in. You could move in and keep it as a homestead or a second home. Keep it as a homestead and you’ll be allowed certain tax advantages if you fulfill the homestead exemption requirements. Using it as a second home will negate the tax advantages but it could be used a place for family gatherings or as a getaway.
Selling is probably the best decision if you live over an hour away from the property and have no reason to keep it. People often underestimate the maintenance time and expenses necessary to keep a house in good condition. Now that you’ve decided to sell let’s look at your options for selling.
List it with a traditional agent. This is how 95% of real estate transactions take place. You’ll meet with local agents and pick one to represent you. But this isn’t as easy as it sounds because in general most agents are not worth your time. When meeting with prospective agents make sure to ask how they plan to sell your house. Will they hold an open house? How many other agents will they call or email? What is their pricing strategy? These are questions they should be able to answer immediately. The last thing you want as a seller is to hire an agent that will take 3% of your sale price just for entering data into the MLS database. Instead you want an agent who will actively go out and sell your property.
List it with a listing company. Recently I listed 2 properties with a company called Listing Spark based in Austin. For their service you pay a monthly fee of $300 and they list your property on the local MLS, Zillow, Redfin, Realtor.com and several others. They will also coordinate showings and send you feedback from other agents. In markets with limited inventory and low days on market homes at the median price or lower generally sell themselves. If you’re listing a property for $200,000 and you sell it in 60 days then you pay Listing Spark $600. If you do the same with a traditional agent they’ll be walking away with $6,000 at closing – 10X the cost of Listing Spark. I’ve personally used them and they’ve saved me $20,000 on resale so far. Remember real estate has a high transaction cost.
Sell it to a local home buyer. They buy houses as is and generally close with cash. The advantage here is that if the home is not in great condition then it’s probably not a good candidate to put on the MLS. However, when selling to a local home buyer you’ll get less for the house compared to the other sales methods. Selling to a home buyer is not for home owners who want to sell their house, instead it’s for people who need to sell their house. Otherwise they, as investors, wouldn’t be able to make money when they re-sell it, which is likely their exit strategy. Most home buyers are small business owners with 1-3 employees who have access to cash to buy houses. Most are genuine, honest people but there are some who will make promises they have no intention of fulfilling. The result will be frustration and wasted time. Here are a few ways to find out if they’re legit.
Before deciding to sell you’ve got to consider the tax burden. Due to the death of the previous owner you as the beneficiary will likely receive a large tax break. If the house was owned several years then it has likely appreciated significantly over that time. Lucky for you that you don’t have to pay taxes on the appreciated value during the time it was owned by the previous owner. Instead you’re only required to pay tax on the value it appreciated while under your ownership. But even this break can backfire on people if they don’t move quickly.
Imagine a scenario with me. You’re mother passes and you inherit her house via probate. The house has appreciated greatly over the 20 years she owned it and because of the tax break you don’t have to pay tax on that appreciation. You’re not sure what to do with the house at first. After 9 months your decide to sell it. It has appreciated $30,000 while you’ve been on the deed. Selling sooner than 1 year and a day after receiving ownership will result in short term capital gains tax. Here’s a comparison of short term vs. long term capital gains taxes:
Short term rate: 28%
- Tax due: $8,400
Long term rate: 15%
- Tax due: $4,500
There is a $3,900 difference if the house is sold before the long term gain rate takes effect. See, now you’ve learned something.
Now go forth and sell on your terms.