Expert: Matt Heisler - 10/2/2007

Question
My mom is in a bit of a financial pickle--she is 68 years old burdened with a 30 year mortgage that she can pay, but only if she keeps working.  She has had a recent health scare and realizes that working until she's 108 years old is not reasonable!  She wants to retire (thank goodness!).  So, in order to keep her in the house, I am willing to pay off the remaining $81,000 of the mortgage.  I would like to not only protect my $$, but also see it grow with the market.  Some of my concerns:  When she passes, will my portion be subject to inheritance tax?  How can I get the most tax benefit from this?  Should I just pay her mortgage or get my own?  
She is not willing to relinquish control, so we thought I could be (roughly) a 21% owner and she would own the rest.  We came up with this number by looking at the assessment and determining what % of that was $81,000.  This way, if she wanted to sell, I would get 21% of the proceeds and she would get the rest...what is your impression of this idea?  Is it do-able?  What are the risks/benefits as you see it?

Answer
Hello Christina:

Here are some thoughts for you to consider.  Please remember that while I am familiar with real estate tax consequences, I am not a CPF, tax accountant or any such thing.  Your situation may be different, and you should always consider you're entire portfolio of assets.

1) Why real estate is a good investment:  LEVERAGE.  Buying a house with 10% down gives you a 9:1 investment ratio.  So if the house goes up 4% a year, on average, you're making 36% on your invested capital, before expenses.  You're mortgage expenses are 6-7%, leaving you a gross margin of about 30%.  That's great!!  But what happens when you have no mortgage?

2) With no leverage, you do what the market does, 1:1.  If the house goes up 4% a year, you make 4%.  That's not so great - since a simple, laddered portfolio in bonds would probably give you 6-7%.  And we're not counting taxes or home improvements here - we're keeping it simple - but that will eat into your profits. See the link below to a google spreadsheet on-line that shows what I'm talking about.

3) The good news is that housing is relatively low risk. Maybe even safer than treasuries!

4) The ownership and taxes is easier.  Yes, you can own 21% of a house, and yes, you can split it up after the sale the same way. Any real estate attorney should be able to accommodate this easily.

5) I do not believe your portion is subject to inheritance tax - because it is yours.  Let's say you bought the whole house, 100%.  It would not be subject to inheritance tax, right?  You didn't inherit it, you own it.

6) You can't pay her mortgage AND own the house.  Banks won't (or shouldn't) allow it.  Her mortgage is in her name, re-distributing the ownership of the house will necessitate some mortgage changes.  The bank may re-issue the note with both your names at your request, but I doubt it.

7) Basically, I'm saying this isn't a good INVESTMENT, but it may work for you personally.  There are other options here:  Reverse mortgages (Sophisticated, but useful in certain  situations), moving to a smaller home.  My main concern for your mom, and for all people who retire on a fixed income, is that your expenses go UP, and your revenues don't.  Taxes, heat, food, gas, cars - they all go up.  At 68, your mom could live to 78, 88, or more.  And inflation will keep going.  If she's in a pickle now, what does the future hold??  My suggestion (and I know this will be SO difficult) is to get your Mom and a good investment planner in a room.  Saving $560/ month (the 81K mortgage) will help for a while, but it won't help for long. (If she spends $25,000 a year in expenses, In seven years (inflation at 3%) she'll be right back where she is today - with no mortgage.)  You need to plan for the next 20 years, and I hope there's more in store!!

Sincerely,

Matt Heisler


http://spreadsheets.google.com/pub?key=psYtGxGwENypnOulFOuMHLA