Real estate is one of the most commonly used assets to transfer wealth to future generations. Some of the most famous billionaires in the world, such as the Rockefellers, have used real estate to keep wealth in their families generation after generation.
But what is the appeal for real estate in terms of intergenerational wealth transfer, and how can even the average American accomplish it?
Real estate is just one of many types of assets that families use to transfer wealth to future generations. But it has some inherent advantages over many other options, including such common choices as stocks.
Read on to learn more about this popular way to build and preserve wealth within families.
Cash Flow Generation
Real estate is capable of producing copious amounts of cash flow that tend to rise over time. Whether residential or commercial, desirable real estate is always in demand, producing a monthly income that generally flows in only one direction: up.
When you rent an apartment, for example, how often does your landlord lower your rent, as opposed to raising it? Odds are that rarely happens, if ever. Regardless of how the value of a real estate asset may fluctuate, the income it provides tends to consistently rise over time.
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Tangible assets like real estate often weather financial crises better than their non-tangible financial brethren. Certainly, the value of real estate can rise and fall, but when times are hard, people value things they can touch and use. During an economic depression, for example, homes still can provide shelter, but you can’t utilize an intangible asset like a share of stock.
While stock shares and other intangible assets can completely lose their value, a home or a building will always retain at least some value, even if that value temporarily falls. This helps sustain wealth over generations and through all types of economic cycles.
Owning an illiquid asset is often viewed as a plus; but, when it comes to generational wealth transfer, it most definitely is.
You’ve likely heard the recommendation from many financial advisors to observe the “24-hour rule” when making purchases, which suggests you wait a full day before spending your money. The reason for this rule is that you’re likely to avoid impulse transactions, thereby saving money in the process.
The illiquidity of real estate works in a similar but opposite fashion. Since you can’t generally unload a home, an apartment complex or an office building overnight, it can help protect your assets from impulse sales once they reach the hands of your heirs. If they inherit cash or a readily liquid asset like stocks, on the other hand, your heirs may be more tempted to spend that money faster than they should, depleting your generational wealth.
Ease of Transfer
Although real estate may be illiquid, it’s also relatively easy to transfer. If you’re not selling a property, all it will take is some paperwork to change the legal owner.
After death, real estate that is properly allocated in an estate plan can pass directly to the desired heirs with essentially just a stroke of a pen. This makes transferring real estate much simpler than actually selling it, another way to help keep wealth within a family.
Astute real estate investors can use the power of leverage to generate outsized gains on their investments. Property that is paid off has equity that can be used for other investments, which leverages the potential return on the property itself as well.
For example, you may be able to take out $800,000 of the equity in a $1 million property and use that to make $100,000 down payments on eight additional properties, which can then be allocated to members of the family. This can both greatly increase your family’s real estate holdings and also leverage those properties to generate higher-percentage gains.
Step-Up in Basis
The family home is the type of generational wealth transfer most often used by Americans, and it’s a good choice. In addition to the emotional component of retaining a family home, houses benefit from a step-up in basis at the time of the owner’s death. This brings the purchase price of the home — for tax purposes — up to the current market value at the time of the owner’s death, essentially removing capital gains taxes from the equation.
For those with homes in high-value areas such as California, this tax benefit could save literally hundreds of thousands of dollars in taxes from flowing out of heirs’ pockets, helping keep generational wealth within a family.
The Bottom Line
Well-chosen real estate has proven to be a great investment historically, particularly for families looking to retain wealth over generations. But succeeding in real estate is not as easy as buying any available property. To maximize your wealth building, choose well-located properties in desirable areas that provide reliable, growing cash flow.
Take advantage of both the leverage and the tax breaks offered by real estate, including the step-up in basis, and consult with experts in the real estate, financial and tax industries to create a long-term, comprehensive plan to secure that wealth for your descendants.
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