Despite the current economic and political turmoil, life is good. You are retired, happy, healthy and have enough stashed away for retirement that your worries are few. Your kids seem fine and it’s time to meet with the lawyer to either plan or review the “estate.”
Well, there is one nettlesome issue. Your son/daughter in law. You never understood why your kid married him/her. But, he/she is controlling or prodigal or greedy. Perhaps, all of those. And your child allows this to go on; oblivious to the fact that you barely see your grandkids or are constantly being asked to underwrite a new car, home renovation or private school tuition. While you are alive and well you can still say “No.”
But what happens when you transition to the great beyond?
Marketwatch’s Moneywise column recently took on this topic. It causes a lot of angst among senior couples who are otherwise happily married. And on weekends like Memorial Day when you have the family as guests “down the shore,” you see the future as you watch the grandkids micromanaged or you are just expected to provide not just housing but food and entertainment for the weekend. After all, you have plenty of money.
This all takes place in the five bedroom duplex in Sea Isle NJ you acquired in 1991. At the time, $675,000 seemed like a crazy amount of money to pay for a second home. You have been going back and forth with the estate lawyer about what to do in a world where the unit next door went last year for $1,900,000 an hour after it hit the market. That’s a big capital gain. The estate lawyer keeps talking about a QPRT, a qualified personal residence trust by which you kind of keep the property for a decade but then it is passed on.
If your child lives in Pennsylvania or another of the handful of “increase in value” states you need to focus on this before it becomes your kid’s nightmare. Because in Pennsylvania, the increase in value of assets you give to your kids is divisible in divorce from the moment they acquire the gift. It’s true even though you, the prospective donor, live in Wilmington and the shore house is in New Jersey.
Here is how the nightmare plays out. You bought the house for $675,000 in 1991. Let’s say in 2000 you gave or sold your son/daughter a half-interest in the place for half of the “then” (2000) value of $900,000 and took back a mortgage. You didn’t like your daughter in law back then either so your transaction was with your kid alone. Now the mortgage is paid off and you and sonny are sitting on $1,900,000 of surf n’ sand. Your grandkids are in college enjoying the 529s you set up. But now there is turbulence between your son and daughter in law. Their estate, which they accumulated over the years is about $1.5 million. That, of course, will get whacked up. But what about this Sea Isle place which you and sonny now own together?
Two answers; none happy. If you gifted the half interest, the $450,000 gift value is his separate asset not subject to distribution. But the gain since the gift ($500,000) is divisible as a marital asset under Pennsylvania law. In an equitable distribution state like Pennsylvania, that means the “outlaw” daughter in law will receive 40-60 percent of the $500,000 increase. It means your son will need to find an extra $200-300,000 from his stash of marital assets to buy out his wife’s Sea Isle interest.
Answer No. 2. You took back a mortgage and made no gift. Your son’s equity started out at -0-. But over 25 years, the mortgage is now paid off. There is no gifted property set aside. The entire interest he has ($950,000) is marital because it was paid off using money he earned over the marriage. Now he needs to pay his bride 40-60% of $950,000 from his share of the $1,500,000 estate that he and bride amassed on their own.
This leads to the “conversation.” It begins: “Dad, we have to sell Sea Isle because I need cash to make an equitable distribution and the shore equity is the whale in the room.” But, you liked this house in 1991 and you still like it now. Your college age kids like it. Your son likes it. Meanwhile, the rest of the marital estate is $300,000 in home equity $200,000 in stock&bonds and $1,000,000 of 401K retirement. Divorce lawyers with reasonable clients can whack that up in an afternoon. But, we need an additional $380-570,000 in cash just to take care of the Sea Isle half interest. It is plausible that unworthy wife gets the Pennsylvania home equity and the cash plus a split of the retirement. But then sonny says “Where do I live? An apartment?”
The good news is seemingly eclipsed by the bad news. Your Sea Isle house provided a wonderful shore experience for a generation and nearly tripled in value while you played inside it. Alas, pops, you are going to have to buy it again to finance your son’s divorce or face the reality of getting rid of it.
The lesson here is that even down the shore, there is no free lunch. Many tax advisers are laser focused on avoiding or minimizing capital gains taxes. But be aware that the son or daughter in law you don’t like may be a shark in the waters as well and that bite could rival Uncle Sam’s. To my knowledge Pennsylvania has not ruled definitively on how a QPRT trust affects increase in value cases. But, before inviting your kids to an ownership role in any asset that has potential for substantial appreciation, stop, look and listen to the advice of an attorney or tax professional who knows the waters.