When we work with personal representatives in probates, there is often a house or other real estate to be sold. Most often the sale is to a third party, but occasionally a beneficiary would like to purchase the property. This post explains how we handle that situation.
Determining a Fair Price
The first step when a beneficiary would like to purchase a house or other real estate from the estate is to determine a fair price. This is important, of course, because to the extent the price is too low, the beneficiary purchasing the property is essentially receiving more from the estate than the other beneficiaries. Conversely, if the beneficiary purchasing the property pays too much, the other beneficiaries receive a windfall at the purchaser’s expense.
To determine the price, we first start with an appraisal of the property. This gives us the best idea of what the property would likely sell for in the open market. Tax bills vary widely from market value and are not accurate enough to be used this way.
However, if the property would sell on the open market, the estate would likely have to pay real estate commission, carrying costs while the property is on the market, and so on. This means that in most cases the estate can expect to net 90-95% of the appraised value in a market sale.
In a sale to a beneficiary, there is no realtor and carrying costs are minimized. This means that in many cases, the estate will sell or transfer to a beneficiary at a small discount, typically the 90-95% of appraised fair market value. This puts the estate in roughly the same financial position as if the property had been sold to a third party and gives the beneficiary a bit of a deal.
Determining the Credit Amount
In some cases, beneficiaries have the financial ability to purchase an asset from the estate using their own funds. In most cases, however, beneficiaries would like to use their inheritance to pay for part or all of the purchase.
The next step in working out the sale terms is to determine the credit amount that is available to the beneficiary as part of the purchase. This credit amount is an advance distribution of part of the beneficiary’s inheritance, paid at the time of the closing.
To understand this, consider a simple estate with four equal beneficiaries, Adam, Betsy, Carla, and David. The estate assets and expenses in this example are:
Assets Expenses
House – appraised value of $150k Funeral - $10K
Bank account – balance of $70K Attorney’s fees - $5K
Final medical expenses - $5K
Adam would like to buy the house at the $150K appraised price. (He has generously agreed to forego any discount, even though an argument could be made for a $140K purchase price.)
The likely total amount available for distribution to the beneficiaries in this example is $200K (total assets of $150K + $70K = $220K, less total expenses of $10K + $5K + $5K = $20K. Since there are four beneficiaries, Adam’s likely share of the estate will be $50K.
However, in determining the credit amount, we want to leave the estate a margin of error to cover a situation in which the numbers don’t come in exactly as expected. In our example, the family is confident there are no unknown creditors and all other bills are known. The estate decides to give Adam a credit of 80% of his likely share, or $40K. This means the estimated assets available for distribution can be off by up to $40K ($10K per beneficiary) and the estate will not come up short in the final distribution to the beneficiaries.
Completing the Sale
Once all terms are determined, the next step is to write the offer to purchase and close the transaction in the same way we would for any other buyer.
In this example, the offer will have a $150K purchase price and give Adam $40K as a partial distribution of his inheritance to apply as a down payment. Adam will need to borrow $110K to complete the purchase. He can receive a standard home loan and the bank will credit the $40K as a down payment. The sale is then closed at a title company in the same way as any other real estate transaction.
Closing the Estate
Once all other matters are wrapped up, the estate can be closed. In our example, if the numbers come in exactly as expected, all beneficiaries are entitled to $50K. Adam received $40K when he bought the house, so he receives $10K of additional cash, for a total of $50K. Betsy, Carla, and David all receive $50K cash.
Questions & Next Steps
Have questions about this? Our office routinely assists personal representatives with probate matters. Call our office for a no obligation consultation.