What would you do? (in-laws trying to support w/home purchase)

Question

This is hopefully not as complicated as it might sound, but was wondering if any of the great minds on this forum have thoughts on best strategy for current situation.

My husband's parents are fortunate enough to own two properties:

House #1: A bungalow a few blocks from the beach in Venice Beach, CA - purchased for basically nothing in the 80s, own outright, probably worth about $1.2 million (guessing).

House #2: A 3bed 2 bath amazing view house with guest house in Topanga, CA - purchased for basically nothing in the 80s, has a 350k mortgage on it, probably worth about $2 million.

(both have extremely low tax basis)

My husband parents are also incredible generous, and were looking into way to help us and his sister purchase properties, without having to wait for the trust to be divided upon their death (knock on wood, not for a long while!).

The first idea was to 1031 the Venice house, giving each child enough to pay ~$500k or so down on a house.

Pros: higher payout

Cons: they have an existing tenant whom they are collecting $4k/mo from that they would lose, each sibling is looking for completely different things, so the timeline of the 1031 is scary in this real estate market, the house would be out of the trust.

The second idea was to take a loan on one (or both?) properties, giving each child just enough for a down payment, essentially (a few hundred grand).

Pros: both houses left in trust, quicker (?), simpler (?)

Cons: less $$, the loans on the properties would increase, would have to pay the loan (likely with the rental income from property #1)

Is there a better option that we just don't know about? I have been on this forum for a minute, but in practice, I don't know what the best way to go about this is. I thought this would be a great place to get any creative ideas that may be out there that we are unaware of. Is there a different way to use the equity in each home without overcomplicating?

Jon Schwartz · Answer

Gracie,

Excellent problem to have! And an interesting conundrum to ponder.

My first word of advice is to consult a 1031 qualified intermediary -- and perhaps one will chime in on this thread. As a layman with a general understanding, I have three concerns:

Firstly, in a 1031 exchange, the upleg (your and your sister-in-law's houses) must be purchased by the same entity that sold the downleg (the Venice bungalow). If the Venice bungalow is in a trust, the two houses bought with the proceeds will have to be in the trust or, at least, owned by your in-laws. Is that the plan? Just want to clear that up.

Secondly, doing a 1031 exchange doesn't eliminate capital gains taxes, it just defers them. So to avoid the taxes, you and your sister-in-law would have to keep the houses purchased for you until your in-laws pass away and the tax basis adjusts on inheritance. How old are you in-laws? How long do you and your hubby and you sister-in-law intend to live in these homes?

Thirdly, one can't 1031 exchange into a primary residence. I suppose this point is moot if your parents own the house and you're technically renters. I wonder if this is scrutinized. I imagine the IRS won't be too happy if you parents don't report any rental income on these two investment houses.

Perhaps you have these questions answered, but they give me pause in pursuing a 1031.

I'd recommend a cash-out finance with a new, 30-year term (though, depending on your in-law's age, maybe a 15-year term is a better idea). Rate is crazy, crazy low right now. Rates are much lower now than the longterm appreciation rate for property in LA, so it's a better move financially (so long as nobody is strapped for cash in the meantime) to hold onto the properties and pay the interest on the finance.

You might also get recommended a HELOC. I'd say you should refinance over pulling a HELOC because HELOC rates are variable. These low rates won't last forever, so you're better off locking in a longterm, low rate now.

I'm curious, do either you or your sister have plans to househack a multifamily? You could take your in-laws gracious gift and really build on it!

All the best,

Jon

Gracie Brown · Answer

Thanks, Ben! It will be our primary residence, though we do hope to find something with value-add potential, and income potential in the form of an ADU. Baby steps investment property :)

Ben Stoodley · Answer

Hi @Gracie Brown , it sounds like you've decided on the first step, to refi. I completely agree there, as @Jon Schwartz mentioned the rates are crazy low right now and HELOC is variable. I am not experienced in the traditional banking world, but I do know they have seasoning requirements for any large sums of money deposited into your accounts. So in addition to speaking with a CPA about the best way to handle the money, I would also be working with your Mortgage broker to better understand your financing options. I assume you want to hold title under your name, using your parent in laws money, so you want to make sure the deposit/purchase transaction is correctly structured. I also assume this purchase will be your primary, rather than an investment, but if it were investment I could certainly offer some other options. Either way, this is a fantastic opportunity for you and your husband to take a huge step forward in your net worths and make living in this crazy expensive state a little easier! Best of luck!

Gracie Brown · Answer

Hi Jon! Thanks so much for your reply! I think at this point they are going to do a cash-out refinance on both properties, but now we have to figure out what needs to be done to transfer the money to us without huge tax implications, or how that all works!!

Jon Schwartz · Answer

I'm dying to know where there is headed!

Julio Garcia · Answer

Line of credit on the houses, use that money to get a property or two (depending on what market you go with). Pay back parents after the cash out refi.

What would you do? (in-laws trying to support w/home purchase)

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