Issues regarding a Home in Probate

My 40 years of experience tells me that roughly 70% of all Probates will have a home that needs to be dealt with. This can create many complicated issues that may create tension between the family. Let’s outline some of the most relevant issues that require some thoughtful consideration. For our fact pattern, let’s assume that Mom and Dad owned the home as Joint Tenants, with Rights of Survivorship. Dad died years ago, Mom just recently passed, and there are three children, A, B and C. The only asset of value in the Estate is a home that has a fair market value of $500,000 and there is a $200,000 mortgage. The mortgage is a 30-year amortization and was taken out when interest rates were low, let’s say 2.5%. The monthly payment is only $1500.

First main issue is “why does the home have to go thru Probate?” So, when Dad died, there was no need for Probate because of the “Survivorship” feature. Mom only needed to record a death Certificate and the home belonged to her. Easy, Peasy. But, when Mom subsequently died, there is no Survivorship feature that carries on to pass the home to the kids. As such, the “chain of title” is broken. Who has authority to sign the Deed over to the kids? The answer is nobody. The Power of Attorney that Mom gave to child A died with Mom and has no authority after her death. So, this is why Probate is needed. The Probate Court will authorize the Executor to sell the home and give the Executor the authority to sign the Deed when the Probate process has been completed. In that regard, I often explain to my clients that Probate is really creating a Power of Attorney for a deceased person. Often the need for Probate isn’t discovered until the kids already have a buyer and have submitted the home to escrow. It is the Title Company that is the bearer of bad news that a Probate is needed.

Once you discover that there is a home or other real estate in a Probate, it is very important to make sure that someone keeps the homeowner’s insurance policy up to date. I have seen situations where a house burns down while it is in Probate and someone let the insurance lapse. The person that fronts the payment for insurance can be reimbursed from the Estate once we get a Personal Representative appointed. The next issue pertains to keeping the mortgage current as well. Remember, that if the mortgage is not kept current, the mortgagee has a lien against the house and they can foreclose that lien. If the family is short of cash, then as your Attorney in the Probate, we will contact them and see if we can get them to hold off on foreclosure while we get the Probate opened and get the family access to cash or other accounts that can be used to keep the mortgage current.

Having an agreement with all of the kids to sell the home is always the least complicated route. It also creates cash for the Estate that may be needed for Probate Fees, paying off creditor claims, paying back taxes, etc. Sometimes the lack of liquidity and cash flow in a Probate is a barrier to what lawyer you hire. Many lawyers will require some sort of retainer, cash up front, before the start of the Probate process. One advantage of Jet Probate is that we have Attorneys that are also Real Estate Agents. As such, many times Jet Probate is willing to waive the requirement for cash up front to cover legal fees if the Executor allows us to sell the home.

But what if Child A, who is also the Executor, wants to purchase the house? And for simplicity for now, let’s assume that Child B and Child C are in agreement. This immediately creates a “conflict of interest” since Child A is a “fiduciary” and cannot participate in any act of “self-dealing”. But this conflict can be waived if Child B and Child C sign a written Waiver of Conflict of Interest. This is one of the reasons that Child A, as the fiduciary for the Probate, needs to have legal counsel to help them get the appropriate Waivers signed.

Now, what about the purchase price? It must be fair to all the beneficiaries, Child A, Child B, and Child C. The Executor has the fiduciary duty of fairness as well. This can easily be satisfied with a qualified appraisal. We recommend the appraisal even though the three children ultimately agree on a price. It never ceases to amaze me how beneficiaries’ memories fade over time.

Next, what do we do about the mortgage? Most mortgage documents have a “due on death clause” that requires the entire mortgage to be paid off at the death of Mom. This is because the lender may want to negotiate a higher interest rate. It is also true that the lender wants to know who they loaned money to. They knew Mom and Dad, and Mom and Dad qualified for the loan. They don’t know Child A. Now, if Child A can qualify for a new loan at a higher interest rate, then everything is ok. But what if Child A doesn’t have the credit necessary to qualify for the new loan? Or what if with a higher interest rate, of say 6%, Child A cannot afford the higher payment? This creates one of the biggest problems that I commonly see in dealing with homes inside of a Probate. What are the options now?

Many times, the family will say “let’s just deed the home over to Child A, and not inform the lender that Mom has died”. In other words, they think that as long as Child A keeps making the payments, the lender will never know that Mom died, and so there is no harm and no foul. It is true that the lender may never know. But there certainly is harm and a foul to the lender. The Executor, who has the duty to represent the entire Estate, including protecting creditors of the Estate, has just breached that duty. So, if the lender does find out, the Executor has breached that duty of fairness to the creditors and is liable for all of the damages. What are the damages? Well first, the lender still has a mortgage against the home, and since the loan documents were violated, the lender can “call the loan”, and now Child A must come up with a 100% of the outstanding loan balance to stop the foreclosure. And, if Child A cannot satisfy the loan, then the house will be foreclosed and will go back to the lender. And let’s suppose that it was Child B that received the home from the Estate and it was Child B who lost the home. Child B lost the money that they paid towards improvements to the home. Child B may also lose the down payment made to purchase the home. Child B lost the appreciation in value that the home had achieved. Child B is very upset now. So, who do they sue? They sue Child A, the Executor of the Estate for breaching their duty to the lender and causing harm and loss to Child B. If Jet Probate was legal counsel, it would never allow this scenario to happen. If Child A insisted on this course of action, Jet Probate would resign as legal counsel. If Child B cannot qualify for the loan, then Child B cannot get the home. For the home to be sold, the Executor must get permission from the existing lender and give them an opportunity to renegotiate the loan.

Let’s turn to another issue. What if Child B and Child C both want the home. What should the Executor do in this situation? Flip a coin? The Executor in this scenario should try to work out resolution with the other kids and if they can’t work it out, then the home needs to be sold.

What if all three of the children agree that the home should be sold, but they can’t agree on the timing of the sale. What if one of the kids, let’s say child C has been living with mom in the home and wants a year or so to continue that arrangement. It’s even worse if it is Child A, who is the Executor, who has a fiduciary duty of fairness to all, has been living in the home and wants to continue that. And what if Child A, while living in the home after Mom’s death refuses to pay rent to live there? Child A argues that they have lived there for years and that Mom never charged rent. Why now? Well, the answer to why now is simple. The asset doesn’t belong to Mom anymore, and Mom isn’t alive to make a deal with anyone. Child A must pay rent to the Estate while the home is being sold. The only exception to that would be if Child B and Child C both agree to allow Child A to live there rent free.

What if Mom dies in a “down market” and there is optimism that the value will come back in a year or so when interest rates drop again? And, what if Child A, the Executor, is in a great financial position and doesn’t need the money now, but Child B and Child C desperately need money and they need to have the house sold as quickly as possible? What now? This dilemma illustrates why I, as an Estate Planner, like to have an independent Executor and not one of the kids. But, the truth of the matter is, that Child A has a duty to liquidate the assets and distribute the cash in the most expeditious manner. The only way they could continue to hold the home for a better market would be if the Will allowed that, which most Wills don’t. In order to force Child A to sell the home, Child B and Child C would need to hire a lawyer and file a Petition with the Probate Court and force Child A to sell the home. This can be time-consuming and expensive.

What are the tax consequences when the home is sold? Generally speaking, Capital Gains Taxes are forgiven at death. This is because there is a “step up” in Cost Basis at death. If the house appraises for $500,000 on Mom’s death, then that is the new Stepped up Cost base. So, if the house is sold for $490,000 there is actually a Capital Loss. This is true even if Mom and Dad originally purchased the home for $190,00 10 years earlier.

What if the home is in Sedona Arizona, and all three kids want to keep the home for either a vacation home for the family or to rent it out on AirBnB. In this scenario, we would generally advise to go ahead and close out the Probate and distribute the home to the three kids. And then, have the three kids create a Limited Liability Company or a Partnership to co -own the house together. Most savvy real estate investors that own rental properties want to own them inside of the LLC. If there is a liability, it is limited to the rental property itself and cannot go against other assets of the owners.

You can see that there are many complicated issues when dealing with a home inside of a Probate. You not only want and need a Probate Attorney familiar with such issues, but also a Real Estate Agent who is familiar with these issues. At Jet Probate, we specialize in selling the home out of the Probate and guiding the Executor through the many issues to prevent him or her from breaching their fiduciary duties.