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The Wall Street Journal
Keeping a property in the family from generation to generation isn't easy. Here are some ways to make the numbers work.
Homes can become family treasures, passed down from generation to generation. But the boon of inheriting such a property can quickly become a burden, in the form of higher taxes and insurance costs.
Cash-poor heirs who must struggle to keep up with the extra expense often find themselves torn between preserving their family heritage and meeting other, sometimes more pressing financial obligations.
"It isn't entirely a financial decision, but whenever the financial part isn't working, you can't have good memories there," says David Hehman, chief executive of EscapeHomes.com, a Web site for people interested in second homes.
Families can make the numbers work in a variety of ways -- from agreeing not to make further developments on the land, to contesting the tax assessment. But before examining such options, it helps to step back and make an honest evaluation of the family's costs, goals and future needs.
New York-based elder-care consultant Marion Somers says she too often sees clients struggling to keep a family property, only to pass it down to children who would have been happier with cash. "Is it worth your energy to scrimp and save and do without to give a house to your kids?" Dr. Somers asks. A home doesn't split easily when children are divvying up the assets, and if no one lives near the property, using it as a vacation home or rental may not be practical.
Other people justify the costs by labeling the house as an "investment," without holding it to the same standards used to judge other investments. Daniel Prebish, vice president of estate planning and business services at financial-services company A.G. Edwards & Sons Inc., St. Louis, says the home should work with a person's risk tolerance, cash-flow needs and time horizon.
For instance, if retirement is fast approaching, a home that eats up precious disposable income may not work, no matter how valuable it will be in the future. Families don't want to be forced to sell during a market trough because their forecasts weren't realistic, Mr. Prebish says.
He suggests people ask themselves: "If it weren't for the fact that I inherited this place, would I be spending 'X' dollars to take care of it?"
An equally important question, says New York-based financial and tax adviser Joel Isaacson, is how people would spend the money if it weren't tied up in equity.
Consider a $1 million home that was purchased for $100,000 and was worth $700,000 when it was inherited. Two things happen to inherited property: The cost basis for tax purposes jumps up to fair-market value at the time of inheritance. And the property immediately qualifies for the long-term capital-gains rate, regardless of how long the beneficiary has owned it. In this example, someone in the highest tax bracket would pay only 15% on a $300,000 gain, for a capital-gains tax of $45,000 on the $1 million sale. (If the purchase price were used as the basis, and the gain was $900,000, the tax would be $135,000.)
Mr. Isaacson suggests determining whether there's a more attractive way to invest or spend the money. Often, he says, investors can do better with a different asset, such as stocks.
"Sometimes with [home] equity there's an opportunity cost," Mr. Isaacson says. If families crunch the numbers first, they'll have more confidence when they act -- whether it's to sell or look for creative ways to hold on.
Perhaps the simplest way to reduce the cost of ownership is to contest the tax assessment. Between 45% and 60% of homes are overassessed, says the National Taxpayers Union in Washington, D.C. In communities across the U.S., meanwhile, property owners who file appeals seeking to lower their property taxes succeed 75% to 90% of the time, according to data cited by the American Homeowners Association in Stamford, Conn.
Another way to lower an assessed value, if the property includes at least several acres of land, is a conservation easement. A conservation easement, usually obtained through a deal with a local land trust or government agency, basically involves a donation or sale of the property's development rights. The property owner retains ownership of the land and its use, while the trust or agency acts as an enforcer, to ensure that the land will not be developed -- by its current or future owners.
For this to work, the land needs to have some conservation value, says Jim Wyerman, communications director with the Land Trust Alliance, the Washington, D.C.-based national association of land trusts.
Landowners can qualify for an easement if the land is being preserved for public recreation or entertainment, to protect wildlife or plants, or to preserve open space for the public's scenic enjoyment, Mr. Wyerman says. The Land Trust Alliance will help interested property owners locate trusts in their area.
Easements tend to lower assessments because the development rights are frequently what drive up a property's value, especially in a scenic or popular location. But owners who want to preserve the option of selling their property should keep in mind that granting such easements can significantly lower resale value, too.
Gold in Them Rights
Before going ahead with an easement, a key decision is whether to donate or sell the development rights. In either case, an easement's value is determined by a professional land appraiser. Donations offer the possibility of significant income-tax deductions in addition to lowering your assessment. Selling the rights, meanwhile, can yield a large amount of cash, while earning a tax deduction as well. This is known in the business as a bargain sale.
For example, Louis Escobar, a dairy farmer in Portsmouth, R.I., inherited the family farm after his mother died in 2002. The property had served as the Escobar family home since 1912 and was worth about $7 million when Mr. Escobar's mother passed away. But it came saddled with property taxes and a $2 million estate-tax bill that Mr. Escobar couldn't afford to pay.
Sold to a Land Trust
Unwilling to see his family land go to developers, he put a conservation easement on 75 acres of the 96-acre property through a bargain sale. An appraiser valued the development rights to the property at $49,000 per acre. Mr. Escobar sold the rights to a land trust for $40,000 an acre. The strategy gave him a $3 million check to cover his bills, and a $675,000 income-tax deduction on the donation. In the meantime, Mr. Escobar can contin
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