Best way to take over 54+ units from my father who is retirement age?

[Philip M.]

Hi All,

First off, thanks to anyone who has any type of insight here, it is greatly appreciated!  I am 36, own a very successful Air BNB at a local ski hill, and am in the process of looking into the best way to get involved in my father's 54 unit rental property business.  He just turned 68 and is ready to be done in an active role as a self-managed landlord for all of his properties.  I have a sister, 34, who also is very interested in getting involved with the business as well.  Some of the properties could be better off in both exterior condition, as well as units rented (which is currently probably at around 50% or less).  Part of the reason for this is that this past year was a tough year for my Dad, as he lost his father, and there was an unfortunate legal battle (which has since calmed down), with an unfortunately uncommunicative sibling in charge of the estate.  It took up most of his time and energy.  My father has also just generally gotten worn out, I believe, from being a self managed landlord and one man maintenance show for all of those units for the past 30+ years.  My sister and I are looking to bring a renewed energy, and urgency to maximize income to the business.  We also see the long term potential of rental properties and what they could mean for both of our growing families.

That said, I am doing a lot of research right now into the best ways to structure the legal entities so as to get us involved and for tax efficiency purposes.  When it comes to management, I would be taking on a more active role in day-to-day maintenance, tenant acquisition, renovations, etc.  However, the goal would be to increase the amount of units rented to close to 100%, maximizing income, then potentially outsource management duties - either by hiring a capable manager/maintenance person, or by getting a property management company involved.  My sister and I are not opposed to some sort of buy in as well, as it would likely help my father clear up some debts, and would just be nice to help him realize some sort of lump sum gain, in addition to what would likely be a share of monthly rental income.

We are looking at setting up a trust to accomplish all of this, but are just at the beginning of this journey.  If there is anyone out there who has advice or experience who could weigh in, it would be greatly appreciated.  Thank you very much!

- Phil

[Bill Brandt]

The best way is to wait until he passes. Other options involve you getting stuck with his low basis and owing lots of taxes or him paying a lot of taxes. He shouldn’t sell then to you and he definitely shouldn’t give them to you. 

If you’re willing to do the work as well as a professional management team for the same price he can keep some money “in the family” by hiring you. But that means you have to become a small time PM, not an exciting prospect. 

What are you trying to change? If it's having father do less work or have more free time he should just hire a PM. That should involve less than an hour or two per week. He could do an exchange in to a NNN lease, but if that's not his field of expertise expect a lower income with his deuces work. But whatever you do, don't transfer ownership to you and/or your sister before his death. That mistake could cost you hundreds of thousands.

[Philip M.]

Hi Bill,

Thanks for the input!  Plan is so that he can retire and him and my Mom can be financially secure on rental income while my sister and I manage the properties in the trust.  I believe ownership would stay with him, as the Grantor of the trust, until he passes.  Then the trust beneficiaries (my sister and I) inherit the properties at the stepped up cost basis.  

As these properties are all paid off in full, we are considering re-financing a few of them at some point for repairs, but also to potentially expand the portfolio as well.

Thanks again,

Phil

 

[Bill Brandt]

What’s the purpose of the trust? He can already leave them to you at the stepped up basis. I assume you’re going to make accounting, tax prep and certainly financing much more difficult, time consuming and expensive with the trust. There probably won’t be an affordable way to refinance them for the repairs, if there is it will be expensive. 

You’re not going to get privacy, tax advantage, or liability protection. You might pay for someone else’s vacation or new boat, but I don’t see how it helps you or your family. 

[Michael Smythe]

Good idea on the Trust as that will avoid probate (required even if there is a will) and your father can control who gets what via the Trust.

Your challenge is what happens if you do all the work to turn the portfolio around and then your father sells it, gives you less than you think you deserve or leaves it to someone else?

You'll need to speak with an Estate Planning attorney to figure out possible protections.

[Philip M.]

Quote from @Bill Brandt:

The best way is to wait until he passes. Other options involve you getting stuck with his low basis and owing lots of taxes or him paying a lot of taxes. He shouldn’t sell then to you and he definitely shouldn’t give them to you. 

If you’re willing to do the work as well as a professional management team for the same price he can keep some money “in the family” by hiring you. But that means you have to become a small time PM, not an exciting prospect. 

What are you trying to change? If it's having father do less work or have more free time he should just hire a PM. That should involve less than an hour or two per week. He could do an exchange in to a NNN lease, but if that's not his field of expertise expect a lower income with his deuces work. But whatever you do, don't transfer ownership to you and/or your sister before his death. That mistake could cost you hundreds of thousands.

A lot of good stuff in here, thanks Bill. I will look into NNN leases to become more acquainted. Before a PM could have a chance at getting good clientele, we have some work on the exterior of some of the buildings to do. We also need to get more than 50% of the units rented so the cash flow is better and we can afford a PM, if that’s the route we go.

One thought would be to be classified as an employee of the different property LLC’s while we accomplish the goals mentioned above, in addition to managing day to day things. The LLC’s could be put into a trust which would negate the tax downsides at the time of my fathers passing (which hopefully won’t be for another 30 yrs or so). My sister and I could then be “employees” of the business, with managerial powers, and the businesses would be in a trust to avoid probate at the time of my fathers passing.  Would love to hear your thoughts on this scenario.

[Bill Brandt]

There are no tax savings from the trust. 

You could check to see if your state honors Transfer On Death (TOD) deeds. These bypass probate at not cost or complication. (I put one on my mom’s primary home.). It can be reversed and/or changed at anytime before their passing. Eliminating any possible benefit of the trust. If it doesn’t, then talk to an estate attorney and tell them your main concern is bypassing probate.  

[David M.]

@Philip M.

You need to consult an estate planning attorney specialist.  

Fundamentally, a "trust" would be good so that you can avoid probate.  Probate is public, requires paperwork, and changing of the Title/Deeds.  A trust requires changing Title/Deed to the trust, but at least its on your terms/time and no probate filings.  Not sure with 54 units units how many Titles are involved...

Yes, the step up in basis is generally important / good. However, if you ALWAYS plan on staying invested in real estate, it doesn't matter as a long as 1031 is good for it. Dont' forget you can 1031 into a DST to "park" your funds if timing/consolidation is an issue, for example.

I THINK you still need a Will, especially if property is across multiple states.

Is your father a NYS resident?  If so,  you'll need to address the "cliff tax."  Get a professional on it!!

I have no idea where you are going with being employees of the LLC...

Just as an aside, you might want to look at this response (and perhaps some of the others):  https://www.biggerpockets.com/forums/311/topics/1159878-do-y... in this thread.  Not saying you need to emmigrate, but there are a few threads now discussing the benefits of other investment options as alternatives and diversification.  Either way, there is plenty to educate yourself when looking to handle wealth.

Hope this helps.  Good luck.

[James Hamling]

@Philip M. have you explored/researched the "asset island" method? 

Have you considered the potential of utilizing the "asset island" method for primary ownership of properties, and than via NNN master lease to individual operating LLC's for business monetization use?

Thus conveying any 1 said property to a specific person/entity for utilization but retaining asset in a trust for various factors. 

[Art Webb]

Recommend you read this article on trusts and step up basis.  It appears if you create a trust it would be a revocable trust to get step up basis.   Should probably consider having all in one or multiple LLCs if not already done or possibly S-Corp. I’m a big fan of a YouTuber Attorney named Mark Kohler.  He is an attorney and CPA. Check out his many YouTube videos. Good luck !!   Art Cost Basis Rules Clarified by IRS By: Spencer M. Baxter, Esq.

JGB November 2023 Newsletter In March of 2023 the Internal Revenue Service made Revenue Ruling 2023-2 clarifying their interpretation of Internal Revenue Code (IRC) § 1014 regarding irrevocable trust basis adjustment at death. This ruling focused specifically on irrevocable grantor trusts commonly referred to as Intentionally Defective Grantor Trusts (IDGT). An IDGT is a type of irrevocable trust that treats the grantor as the trust owner for income tax purposes (they pay the income taxes for the trust during their lifetime), but the assets contributed to the trust (a completed gift for tax purposes) are not included in the gross estate of the grantor at their death. It was previously believed that the use of an IDGT not only removed the trust assets from the decedent’s estate for estate tax purposes but also resulted in a basis adjustment to the fair market value of the trust assets on the decedent’s date of death. Although this was the first time the IRS formally focused on this issue, it is now clear that the IRS will disallow basis adjustment on assets held in an IDGT. IRC § 1014 Internal Revenue Code § 1014 has been a long-standing tenant of the US tax code, dating back to the early 1930’s where it was formally classified under Section 811, Title 26 of the Internal Revenue Code. Through various iterations over time, IRC § 1014 now provides basis adjustment at death (sometimes also known as a step-up in basis) and can be very effective at reducing capital gain taxes after the death of the property owner. The effectiveness of § 1014 depends on the titling/coordination of the decedent’s assets prior to their death. To receive basis adjustment at death the asset must qualify as part of the decedent’s taxable estate and also qualify as either a bequest, a devise or pass by inheritance. Basics Of Cost Basis To further understand basis adjustment at death, we should first explore asset basis treatment during an owner’s lifetime. If person X purchased 50 shares of stock at a price of $10.00 per share, their cost basis is $10.00 per share. If X later sold these shares for $25.00, they would subtract the original cost basis ($10.00) from the new sales price ($25.00) to establish the taxable capital gain ($15.00) on the stock sale. Simply put, the smaller the variance between the basis and the sales price of an asset, the less capital gains taxes are due from the sale. If X passed away after their initial stock purchase and named person B as a beneficiary in their Last Will and Testament, B’s new inherited stock basis would be the stock fair market value on X’s date of death. The stock transfer at X’s death qualifies as a bequest under IRC § 1014 and thus qualifies for basis adjustment to the new fair market value at X’s death. If the value of the stock on X’s date of death was $50.00 per share (the new basis) and B later sold the stock for $50.00 per share, no capital gains would be due as a result of the § 1014 stepped-up basis adjustment. Revocable Living Trust Basis Treatment If we were to change the example and instead have X owning the stock shares in the name of their Revocable Living Trust (RLT), the same stepped-up basis adjustment would occur at X’s death. Assets titled in the name of X’s RLT qualify for basis adjustment because an asset transfer from a RLT is considered a § 1014 “bequest” and RLT assets are still considered part of X’s taxable estate. It should be noted that basis adjustment does not apply to stocks held within other Qualified Retirement vehicles like Annuities, IRAs or 401(k) accounts. During RLT administration (after the death of the grantor), it is common for Trustees to liquidate/convert stocks or other capital assets shortly after the death of the grantor. Expediting the liquidation of RLT assets often minimizes capital gain taxes and results in smoother distributions to beneficiaries. Trustees should always consult with their financial advisor, accountant, and attorney before making the decision to quickly liquidate trust assets. While basis adjustment may seem rather self-evident, appropriately navigating the particular tax nuances often requires a seasoned practitioner. Many people have attempted (and failed) to outwit the IRS on this matter. For example, IRC § 1014(e) specifically denies basis adjustment on property that is gifted during the one-year period prior to the decedent’s death, that is then reacquired by the original individual who transferred the property. In essence, you cannot simply transfer property to a dying person who then leaves it back to the taxpayer/original owner to leverage a basis adjustment to the date of death value. Do I Have To Changes My Trust? To be very clear, Revenue Ruling 2023-2 does not impact those utilizing Revocable Living Trusts. The firm has received numerous questions from clients over the last year regarding this Revenue Ruling, and unless you have an Intentionally Defective Grantor Trust as part of your estate plan, you should not be concerned with the Revenue Ruling discussed. With that said, vigilance is still necessary to stay abreast of current and future legal changes likely to impact your estate plan. In just the last few years we have seen two separate legislative adjustments to the treatment of Inherited IRAs (Secure Act and Secure Act 2.0). Furthermore, with the expiration of increased estate tax exclusions contained in the Tax Cuts and Jobs Act, in 2026 we could see a dramatic reduction of the federal estate tax exclusion by more than fifty percent. If you have not taken the time to recently review your estate plan with your respective attorney, there is no time like the present to do so.

[John Clark]

Quote from @Philip M.:

Hi All,

First off, thanks to anyone who has any type of insight here, it is greatly appreciated!  I am 36, own a very successful Air BNB at a local ski hill, and am in the process of looking into the best way to get involved in my father's 54 unit rental property business.  He just turned 68 and is ready to be done in an active role as a self-managed landlord for all of his properties.  I have a sister, 34, who also is very interested in getting involved with the business as well.  Some of the properties could be better off in both exterior condition, as well as units rented (which is currently probably at around 50% or less).  Part of the reason for this is that this past year was a tough year for my Dad, as he lost his father, and there was an unfortunate legal battle (which has since calmed down), with an unfortunately uncommunicative sibling in charge of the estate.  It took up most of his time and energy.  My father has also just generally gotten worn out, I believe, from being a self managed landlord and one man maintenance show for all of those units for the past 30+ years.  My sister and I are looking to bring a renewed energy, and urgency to maximize income to the business.  We also see the long term potential of rental properties and what they could mean for both of our growing families.

That said, I am doing a lot of research right now into the best ways to structure the legal entities so as to get us involved and for tax efficiency purposes.  When it comes to management, I would be taking on a more active role in day-to-day maintenance, tenant acquisition, renovations, etc.  However, the goal would be to increase the amount of units rented to close to 100%, maximizing income, then potentially outsource management duties - either by hiring a capable manager/maintenance person, or by getting a property management company involved.  My sister and I are not opposed to some sort of buy in as well, as it would likely help my father clear up some debts, and would just be nice to help him realize some sort of lump sum gain, in addition to what would likely be a share of monthly rental income.

We are looking at setting up a trust to accomplish all of this, but are just at the beginning of this journey.  If there is anyone out there who has advice or experience who could weigh in, it would be greatly appreciated.  Thank you very much!

- Phil

You should take advantage of your father’s experience. It seems to me that rather than 54 doors, you/sis/dad would be better off with fewer, but better doors. So the three of you would sit down where you should be in the market, and how big. Then you and sis start looking at the market to find properties that fit your joint goal, and dad looks at his portfolio to find the places he wants to sell to get the funds to arrive at the model. 

Here’s the kicker; you and sis have to convince the three of you that the places you want to acquire meet that model, and let dad critique your proposals. That way you get insights as to how to think about real estate acquisition successfully. Likewise, when dad says he wants to get rid of properties, you ask him what factors led him to his conclusions.

All the while you two are doing the gofer work and dad is supervising/imparting wisdom. In the process you are getting rid of the dross and dreck.

Whether the property should be in land trusts or whatever is not your main concern. Learning how to evaluate properties and shaping an agreeable portfolio is. Dad can put properties into trust (or whatever) as he goes along.

Once Dad drops off the twig, then you and sis can enjoy the stepped up basis and the knowledge gained, and know that Dad didn’t feel like he was shunted aside.

[Jake Baker]

@Philip M.

Best to link up with a real estate attorney and CPA to get your ducks in a row.

[Kory Reynolds]

Just one idea, but probably a dozen ways to accomplish this. 

1) Father drops the property into an LLC, if it isn't already

2) You and Sister are introduced as "profits interest" members of this LLC

3) You can then structure how the profits are shared, but Dad owns all of the appreciation that has already occurred, and would get a step up upon death. You arrange the LLC deal so that in the waterfall, you and Sis get the majority of profits over this baseline threshhold. Maybe give Dad a preferred return to reflect how much capital he has locked up on this deal.

IE say property is worth $4m with no debt (keeping it simple), and cash flows $800k annually. The below terms are near infinitely flexible from what I have below, but the idea is that you and Sis only share in the future profits - no part of Dad's original appreciation. Operating Cash Waterfall looks as follows:

1) Dad gets 10% pref on his unreturned capital ($4m * 10%) = $400k

2) Dad / You / Sis split the next profits 20 / 40 / 40 - $80k / $160k / $160k

Cash Waterfall on a capital event (cash out refi or sale) as follows - lets say it sells for $5m in a few years

1) First dad is paid back on his unreturned capital + any unpaid preferred returns - $4m

2) Then balance is split Dad / You / Sis   20/40/40 - $200k / $400k / $400k

You could do management fees for additional involvement, fees upon a sale, etc - can go wild.  Just think of Dad as an LP investor and this is a syndication, and he is contributing property.

If Dad passes away before it is sold in this structure, his Partnership interest is what is stepped up to FMV, which can allow for a step up in the basis of his share of the assets to FMV. IE in above if instead of selling for $5m, your father passes away when it is worth $5m. Effectively his share of the building is stepped up to $4.2m (his share of the FMV). Discuss valuation discounts as they may apply with your estate tax experts.

[Philip M.]

Quote from @Kory Reynolds:

Just one idea, but probably a dozen ways to accomplish this. 

1) Father drops the property into an LLC, if it isn't already

2) You and Sister are introduced as "profits interest" members of this LLC

3) You can then structure how the profits are shared, but Dad owns all of the appreciation that has already occurred, and would get a step up upon death. You arrange the LLC deal so that in the waterfall, you and Sis get the majority of profits over this baseline threshhold. Maybe give Dad a preferred return to reflect how much capital he has locked up on this deal.

IE say property is worth $4m with no debt (keeping it simple), and cash flows $800k annually. The below terms are near infinitely flexible from what I have below, but the idea is that you and Sis only share in the future profits - no part of Dad's original appreciation. Operating Cash Waterfall looks as follows:

1) Dad gets 10% pref on his unreturned capital ($4m * 10%) = $400k

2) Dad / You / Sis split the next profits 20 / 40 / 40 - $80k / $160k / $160k

Cash Waterfall on a capital event (cash out refi or sale) as follows - lets say it sells for $5m in a few years

1) First dad is paid back on his unreturned capital + any unpaid preferred returns - $4m

2) Then balance is split Dad / You / Sis   20/40/40 - $200k / $400k / $400k

You could do management fees for additional involvement, fees upon a sale, etc - can go wild.  Just think of Dad as an LP investor and this is a syndication, and he is contributing property.

If Dad passes away before it is sold in this structure, his Partnership interest is what is stepped up to FMV, which can allow for a step up in the basis of his share of the assets to FMV. IE in above if instead of selling for $5m, your father passes away when it is worth $5m. Effectively his share of the building is stepped up to $4.2m (his share of the FMV). Discuss valuation discounts as they may apply with your estate tax experts.

 Kory, really interested in exploring this concept, thanks very much for sharing.  Sorry if I didn't gather from your initial comment, but does this scenario still avoid the primary issue of being named as a part owner, losing us the step up in basis later on down the line?  We wouldn't want to sacrifice that, but I am really interested in the profit sharing option as mentioned in your post, if it can be achieved without sacrificing the step up.  Also, it's very possible we wouldn't be selling the properties in our lifetime either, and perhaps we would even be expanding the portfolio.  Thanks again!

[Kory Reynolds]

Quote from @Philip M.:

Quote from @Kory Reynolds:

Just one idea, but probably a dozen ways to accomplish this. 

1) Father drops the property into an LLC, if it isn't already

2) You and Sister are introduced as "profits interest" members of this LLC

3) You can then structure how the profits are shared, but Dad owns all of the appreciation that has already occurred, and would get a step up upon death. You arrange the LLC deal so that in the waterfall, you and Sis get the majority of profits over this baseline threshhold. Maybe give Dad a preferred return to reflect how much capital he has locked up on this deal.

IE say property is worth $4m with no debt (keeping it simple), and cash flows $800k annually. The below terms are near infinitely flexible from what I have below, but the idea is that you and Sis only share in the future profits - no part of Dad's original appreciation. Operating Cash Waterfall looks as follows:

1) Dad gets 10% pref on his unreturned capital ($4m * 10%) = $400k

2) Dad / You / Sis split the next profits 20 / 40 / 40 - $80k / $160k / $160k

Cash Waterfall on a capital event (cash out refi or sale) as follows - lets say it sells for $5m in a few years

1) First dad is paid back on his unreturned capital + any unpaid preferred returns - $4m

2) Then balance is split Dad / You / Sis   20/40/40 - $200k / $400k / $400k

You could do management fees for additional involvement, fees upon a sale, etc - can go wild.  Just think of Dad as an LP investor and this is a syndication, and he is contributing property.

If Dad passes away before it is sold in this structure, his Partnership interest is what is stepped up to FMV, which can allow for a step up in the basis of his share of the assets to FMV. IE in above if instead of selling for $5m, your father passes away when it is worth $5m. Effectively his share of the building is stepped up to $4.2m (his share of the FMV). Discuss valuation discounts as they may apply with your estate tax experts.

 Kory, really interested in exploring this concept, thanks very much for sharing.  Sorry if I didn't gather from your initial comment, but does this scenario still avoid the primary issue of being named as a part owner, losing us the step up in basis later on down the line?  We wouldn't want to sacrifice that, but I am really interested in the profit sharing option as mentioned in your post, if it can be achieved without sacrificing the step up.  Also, it's very possible we wouldn't be selling the properties in our lifetime either, and perhaps we would even be expanding the portfolio.  Thanks again!

This scenario does avoids the issue of being named as a part owner. What instead is happening is that for estate tax purposes, instead of directly holding real estate your father would hold an interest in Real Estate HoldCo LLC - a partnership interest. So his step up in basis would be in his partnership interest, which by some tax elections lets you make that step up in the basis of the assets to whatever his FMV share of those assets is upon his death.

Any of the partnership that you and your sister own when he passes away would not receive a step up to FMV. So if at death it is worth $5m, and of that $5m based on the waterfall agreement you and your sister would get a combined $800k - that $800k does not get stepped up, just the $4.2m that belongs to your father does.

If your father is subject to estate taxes, and there are substantial discounts taken on the valuation of partnership interests in his estate - that cuts back on the step up, but it saves steeper estate tax, so it is a worthy trade most of the time.

[David M.]

@Philip M. the key issue here is when the decedent doesn't have 100% interest in the asset, then the entire basis of the asset doesn't get a step up in basis.  As mentioned, only your father's interest gets stepped up.  So, your eff. basis becomes sort of the average...