Millennials are set to become the richest generation in history when an estimated $90 trillion of wealth is passed on.

The intergenerational wealth transfer has been a pervasive discussion since the report by global property consultant Knight Frank was released. The report estimated that $90 trillion is expected to be transferred over the next 20 years.

However, when this transfer happens, it won’t just show up in bank accounts. When we look at where Australian wealth is held, two thirds of it is in residential property. It is likely that many beneficiaries of the intergenerational wealth transfer will receive the majority of their inheritance in bricks and mortar.

There are consequences and considerations around how a transfer should be structured. Most are tax related but there are other factors to consider. It is likely that you will have a sibling or other beneficiaries that the estate is split with. Unlike other assets like shares and cash that can easily be split down the middle, housing presents some issues.

This episode goes through the considerations for bequeathing and inheriting a property.

You can read the full article here.

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You can find the transcript below:

Mark LaMonica: Welcome to another episode of Investing Compass. Before we begin, a quick note that the information contained in this podcast is general in nature. It does not take into consideration your personal situation, circumstances or needs.

Alright. Shani, I need to do another survey plug. I don't know why you always assign this stuff to me.

Shani Jayamanne: You're just better off the cuff.

LaMonica: Okay. Well, we have a survey and we would like people to fill it out. It would be very helpful for us. The survey is in the podcast notes. We think it will take about five minutes; multiple choice questions in there. It's all about whoever is filling it out, so you should know the answer. And we will draw, we think we said August 15th.

Jayamanne: August 15th?

LaMonica: Yeah. We're going to give a little bit of time. We will draw a winner.

Jayamanne: And they'll get a $250 Visa gift card.

LaMonica: Yes. And as I joked last time, you can use this gift card to take us out for drinks. Or if nobody wants me to come, you can take Will and Shani out. But anyway, we would appreciate it. It would be a big favor. It would make Shani happy because she was the one that went in and created the survey.

Jayamanne: We're just very curious about how you found us, mainly because we don't really run ads outside of Morningstar.

LaMonica: We don't really?

Jayamanne: No. Well, we don't at all.

LaMonica: Yeah. Exactly.

Jayamanne: We don't have external guests, so we just want to know how you found us because it'll help us a lot to keep the podcast going.

LaMonica: Yeah. Maybe we could help other people find us. So, Shani is coming down with a cold.

Jayamanne: I am.

LaMonica: She claims. See, I think what's happened is we actually have a big Social Week. We have drinks tomorrow with Sharesight.

Jayamanne: Yes. Yes. So, if you've got Morningstar Investor, Sharesight have their portfolio manager integrated into our product.

LaMonica: Yeah.

Jayamanne: We love the team there.

LaMonica: Yeah. It's the team, mostly the marketing team, but also Doug, the CEO, is coming. And so, I think Shani's just trying to get out of that.

Jayamanne: I'm not. I'm not. I promise. I really like the Sharesight team.

LaMonica: Okay. So, she's come up with this fake cough.

Jayamanne: Should we get into this?

LaMonica: Yeah. And by the way, Shani, you scheduled the drinks between three and five.

Jayamanne: Yeah. It's during work hours.

LaMonica: Yeah, so she wouldn't have to do any work. Alright. Let's get into the episode, Shani.

Jayamanne: Okay. So, we recently did an episode on how to incorporate an inheritance into a financial plan, and it was very popular. So, maybe a lot of our listeners...

LaMonica: …hope to inherit something.

Jayamanne: Exactly.

LaMonica: Or want to go to their kids and say, don't plan on inheriting anything.

Jayamanne: Yes. Maybe we should plug our podcast at Estate Planning firms.

LaMonica: Yeah. That sounds like a lot of fun.

Jayamanne: Okay. And that episode focused on the fact that the intergenerational wealth transfer was going to transfer around $90 trillion of wealth over the next 20 years.

LaMonica: And that is a lot of money, although most of it will probably go to like three people.

Jayamanne: Yes. And this was based on a report by property consultant, Knight Frank, and there were a few findings in this report, but ultimately, it's going to widen the wealth inequality gap in Australia.

LaMonica: And the millennials for all of their complaining are going to become the richest generation in history.

Jayamanne: It's a shame that you're going to miss out by a year and a half, Mark, because you did mention in that episode, you're almost a millennial.

LaMonica: I am almost a millennial, but I don't think that's why I'm not absolutely loaded. Okay. So, Shani, we're going to go through how you'll actually receive your inheritance. So, there are a couple of different forms you could get it. You may receive cash, you could receive securities like shares or bonds, or you could receive a house.

Jayamanne: Exactly. And that's what we're going to talk about today. When this intergenerational wealth transfer happens, it won't just show up in bank accounts. When we look at where Australian wealth is held, two-thirds of it is held in residential property.

LaMonica: Which is, I guess, unsurprising. But yeah, kind of crazy. That means, of course, that the most likely situation for many recipients is that they will receive the majority of their inheritance in bricks-and-mortar.

Jayamanne: And you know, there are situations where this won't be the case. What we're also seeing is that Australians are often going into their later years with chronic illnesses, many that will lead to needing full-time care. And full-time care and nursing homes are expensive. The trade for this sort of care often involves home equity or selling a house to access the equity. And these agreements can vary in complexity. But again, this is where planning is stressed because it can help all parties that are involved in the process, children and parents.

LaMonica: But with that aside, it is still very likely that if you are receiving an inheritance, it could include a house.

Jayamanne: And there are a few consequences to this and how a transfer should be structured. Most attacks consequences, but there are other factors to consider.

LaMonica: And it's likely that you will have a sibling or other beneficiaries that the estate is split with, unless you're me, an only child.

Jayamanne: Lucky you, Mark.

LaMonica: Yeah, lucky me. Unlike other assets like shares and cash that can be split down the middle, a house can't unless you really like your sibling and want to live with them.

Jayamanne: Yeah, I guess so. And adding to this complexity, almost half of all wills in Australia are contested. Those that are contested on the basis of family provision claims have over 70% likelihood of being successful. This means that even if the will is specific in the way that it is allocating assets, it can be contested on a needs' basis. It gets particularly messy if a beneficiary is living in the house as well.

LaMonica: And you know how everyone always tells you it's really important to have a will. And I'm not saying it's not, but just the fact that half of all wills are contested and 70% of them, the people contesting it win, it's like why bother.

Jayamanne: Some great advice there from Mark LaMonica.

LaMonica: You should still probably have a will. I just wouldn't pay too much for it because, well, you go get some great lawyer, it's still contested.

Jayamanne: Mark, please move on.

LaMonica: Okay.

Jayamanne: Before we get in trouble.

LaMonica: By who?

Jayamanne: You know we could get sued. Anyway, continue on.

LaMonica: So, as you can imagine, there are many ways that inheriting a house can settle at a already emotionally charged time. So, we're going to go through some of these considerations to inheriting a house now so you can prepare.

Jayamanne: Okay. So, let's start with the straightforward, which is around the tax consequences. And we'll talk about primary places of residences or PPRs. And basically, what this means is that the person lived there.

LaMonica: So, if it was a primary place of residence, the home is valued at the time of the owner's death. CGT, so capital gains tax, will apply based on this value. However, you do get a bit of breathing room. It would be unrealistic to expect a beneficiary to put the house on the market immediately. So, there's two years leeway to dispose of the property. And if history in Australia is any guide, the house will appreciate by about 70% in that two years. So, that's good. And if you do this, there is a capital gains tax exemption.

Jayamanne: And if you don't dispose of the property within two years, you pay CGT based on the value of the property at the time of the owner's death.

LaMonica: And there's probably a few of us that listen to this podcast that can emphasize with the situation, where two years can feel quite short when dealing with selling a loved one's property. You have to clean out the property, store, sell, donate or discard possessions after sorting through them, maybe carry out some repairs and market the property and sell it. So, it's very important that if there's multiple beneficiaries that they're all on the same page about the timeline to sell the property.

Jayamanne: There's also the ability to extend the CGT exemption period by making it a beneficiary's primary place of residence before the two years lapse.

LaMonica: Okay. We're going to go through an example, Shani. People like examples. A parent passes away and the house is valued at $800,000 at the date of their death by a probate and a estate valuer. It takes two years to get the house in order. But the daughter, who is one of the beneficiaries, wants to do minor renovations on the place over the course of the next year before they sell.

Jayamanne: And this is a likely scenario, right? Usually when you have an elderly parent, the house may have work that needs to be done to get it back into a sellable condition.

LaMonica: Exactly. So, there's a couple of options here. If this daughter moves into the property for that year while the renovations are taking place and it is her primary place of residence, CGT is not applicable on the property.

Jayamanne: If she doesn't move into the property but holds onto the property for the next year while the renos are undertaken, she'll have to pay CGT. So, saying that third year when she sells, it's worth $900,000, she would have a capital gain of $100,000. If she moved in, the whole $900,000 is CGT exempt.

LaMonica: Okay. So, let's move on to inheriting an investment property or a place of business, so a commercial property.

Jayamanne: So, the rules for properties outside of a PPR are split into two. So, those that are purchased before or after September 1985. Properties that are purchased before 1985 are valued at the time of the owner's death. Properties that are purchased after 1985 have a cost basis of the original purchase value and CGT must be paid on all the unrealized gains. And this could be a significant amount as houses have appreciated significantly in Australia over the last 30 years.

LaMonica: It's also worth noting that if the property has a tenant at death, the rent received will attract income tax.

Jayamanne: Now, the tax considerations are out of the way. It is important to understand the other nuances with receiving a property as inheritance.

LaMonica: And we touched on this at the beginning of the episode, but it's likely that you're going to receive a house and share it between multiple beneficiaries. Even if they're not in the will, they can just contest it, right?

Jayamanne: I guess so, Mark.

LaMonica: Yeah. Exactly. And we can see from the number of contested wills that you're probably going to lose if they contest it.

Jayamanne: And there's no way that you're able to predict how people act when the assets of the will are being dispersed. We think we know people, but we can see from the number of contests that it isn't always the case.

LaMonica: And we were talking about this article before. We started recording this. You and Will read it.

Jayamanne: Yes.

LaMonica: I have not read it, but from your description that the AFR wrote this article, and a child still got a share of her father's estate after she planned to kill him.

Jayamanne: Yes.

LaMonica: She was unsuccessful at that.

Jayamanne: At the killing, but she did access the will.

LaMonica: She was successful in contesting the will. She was unsuccessful in killing him. He died of...

Jayamanne: Of unrelated causes, we think.

LaMonica: Yeah. So, hopefully after a thorough police investigation.

Jayamanne: Yes. So, it is likely that you will have some conflict if intentions aren't completely clear and understood by all parties. And it's fair to say that you might have conflict even if everybody is in agreement at the time of estate planning.

LaMonica: The point is that you can't decide to sell the kitchen if somebody wants out and the others want to keep the house. So, there's a few options of conflicts arise about the future of the property. And we'll go through a couple of the most common ones.

Jayamanne: Okay. So, the first is just buying out the other beneficiaries. So, mortgage can be taken out by a beneficiary that is wanting to keep the property and if they're in a position to buy out the other beneficiaries.

LaMonica: And you can also come to some sort of private agreement. You can get a solicitor to help draft an agreement where the beneficiary wants to keep the property but avoid the extra cost of a mortgage and will pay funds directly to other beneficiaries. This could be in the form of a monthly payment.

Jayamanne: And the last is selling the house. Unfortunately, the easiest solution is to sell if the parties are not in agreement about the future of the property. If the beneficiary that is looking to keep the property can't afford to buy out the other beneficiaries or arrange a private agreement, a sale is the only logical conclusion. If you want to make it an expensive process, you can always go to court where the most likely outcome is that there will be a for sale of the property anyway.

LaMonica: And to complicate matters further, there might be a mortgage still attached to the property. What many beneficiaries are forced to do is sell a property when they're not able to service the mortgage. Another layer of complexity is if you have the situation with multiple beneficiaries that have varied financial circumstances. Some may be able to afford their portion of the mortgage, others may not be able to.

Jayamanne: Exactly right. Many siblings have varied financial circumstances and lead very different lives. So, it's likely that you could be in a scenario where even if all the beneficiaries want to keep the house, they're unable to afford keeping it.

LaMonica: And the last factor that we wanted to speak about is what you need to consider – or the fact that you do need to consider the sentimental and emotional toll of inheriting a house. And we've spoken a lot about the tax consequences and the logistics of navigating a property inheritance.

Jayamanne: Ultimately, if you inherit a house, it's likely that you have memories attached to the people and the place. Unlike other assets like shares and cash, it's a physical asset that can make it more difficult to let go. This can cause conflict if multiple beneficiaries are involved that want different outcomes for the house.

LaMonica: And the ATO can dictate what is the most efficient way to dispose of an asset, but it's important to acknowledge that this timeline doesn't always fit in with a grief of losing a loved one. It's a difficult time for many people and loss isn't always about rushing to the finishing line. Understand what works for you and how to move through the process in the best way for all the beneficiaries.

Jayamanne: So, to end this, we have three tips to make the process easier. The first is to mitigate risk. And although wills aren't ironclad, ensuring that the owner of the estate has professionally prepared legal documents that are regularly updated will mitigate risk. And there are several parts to this. The most common issue faced is when assets are gifted in a will that aren't properly structured to give away. So, beneficiaries can come into complications. For example, if the house is held in a different ownership structure, which is very common with investment properties, or if the house has multiple owners. Comprehensive estate planning will help make the process smoother for all parties.

LaMonica: And the second, and we talked about this in our other episode about estate planning and how that can benefit people and how we don't think they should put it part of the plan, but just have a conversation. So, it's just really important to have that discussion and make sure that the intentions are clear.

Jayamanne: Yes. Encourage a conversation where the intentions of the will are verbalized. Although this has no legal validity, it will give a clear reference point to the wishes of the deceased and a starting point to a constructive decision about how assets will be handled when the owner dies.

LaMonica: The last tip is that nothing is certain and don't count your chickens before they hatch. We went through this in the episode that we mentioned at the beginning of this, how to incorporate a potential inheritance into a financial plan.

And the short answer is don't. Regardless of what happens with any inheritance, ensure you are in a position where you are not relying on it to achieve your financial goals. We can see from the will contest that there's a chance that things will land differently to how you thought. If it does not eventually, you won't have to dig yourself out of a hole that you can't get out of.

So, thank you very much for listening. Really appreciate it, and we would really appreciate if you could fill out that survey for us. So, thanks again.

 

(Disclaimer: Any advice in this podcast is general advice or regulated financial advice under New Zealand law prepared by Morningstar Australasia Proprietary Limited and/or Morningstar Research Limited without reference to your financial objectives, situations or needs. You should consider the advice in light of these matters and any relevant product disclosure statement before making any decision to invest. To obtain advice for your own situation, contact a financial advisor.)