As the baby boomer generation approaches one of the largest transfers of wealth in U.S.[i] history, individuals are focusing on how to facilitate the flow of their assets to their children, grandchildren and great grandchildren.  Passing along more liquid assets – like stocks, bonds and cash – is somewhat straightforward.  In no uncertain terms, you can see what you have to distribute.  However, hard assets – illiquid items like property, art, jewelry and other items you may not buy strictly for investment purposes – are not always as simple. Since families rarely keep a comprehensive inventory of these assets, their value may be outdated or unknown and family members may have different expectations of how to handle them.

It’s no wonder that individuals struggle to talk about these types of assets during the estate planning process.  They don’t know how to discuss them with, or distribute them to, their heirs.  As a result, hard assets are often completely overlooked – in spite of their potential value.  Like with liquid assets, illiquid assets require a formal plan that begins with several conversations between the family decision makers, financial advisors and, often times, outside appraisers. To kick-start the illiquid assets distribution discussion, here are four conversation kick-starters that can lead to an effective plan.

How Much Is It Worth?

Regardless of whether you want to pass down the asset itself or any profit from the sale of that asset, you must start with its fair market value.  This is the foundation for any plan to pass on illiquid assets because it attaches an actual, current number to an item which has almost always changed in value over time.  For example, one of our clients initially had a $250,000 insurance policy on a collection of artwork that appraisers later estimated to be worth $1 million.  That client wasted no time in adjusting the policy once they knew the actual value of the asset.  The magnitude of the change in value isn’t always easy to pinpoint, so appraisals should be made by certified professional who can provide the most accurate and up-to-date information to inform decision making.

Who Wants It?

Beyond actual monetary value, it’s important to consider the emotional or sentimental value of the asset, either to you or your heirs.  Your children or grandchildren may feel differently about the item than you do, which should be discussed before making any final estate planning decisions.  If you have multiple heirs who all want a share, you’ll need figure out how to divide it equally if the asset can be divided. If it cannot be split, you’ll need to plan for how to equitably split other assets.  If some, but not all of your heirs want to keep the asset, it might be more effective to create an equitable buyout situation that transfers ownership to the heirs who want it.

How Can It Be Passed On?[ii]

You have a number of options for passing on illiquid assets.  In most situations, the best choice is to allow an heir to inherit the asset itself. Illiquid assets receive a step-up in cost basis that alleviates some of the capital gains tax burden even if the inheritors sell it. You can also put the asset in a trust, family partnership or LLC and formalize the transfer of ownership in a tax efficient way, while also saving on future estate taxes.  As a last-resort, if you don’t feel like your heirs understand the asset enough to sell it for a fair price, you can opt to sell it yourself, pay the appropriate taxes and gift the cash.  We still recommend passing the asset itself to the next generation, which is why communication and transparency are so important.  The last-resort option can be avoided if your heirs understand the true value of the asset.

What Do We Do With the Family Business?

Family businesses have different considerations based on the parties involved, making a conversation even more critical before developing a formal plan.  Multiple heirs may have different ideas of how to run, or whether to run, the business in the future.  This is one area where succession planning and estate planning merge, where you need to determine who runs the business in the future and the ownership stakes for each of the heirs.  If nobody wants to run the business, you may consider finding a buyer whose goals for the business align with your own.  Then you can pass on the profits as cash.  These conversations should occur as early as possible, as succession planning can take years, or even decades, to complete.

In most cases, conversations involving illiquid aren’t easy conversations to have since they’re usually emotionally charged.  That’s why some individuals ignore them.  But disregarding these potentially valuable assets may create legal challenges for your family in the future.  It may also create conflict if not handled properly and transparently.  Discussing these questions will put you and your family on the path toward a comprehensive plan which financial and legal professionals can help execute.  By using them as a guide, passing on those hard assets won’t be so hard after all.

For more information on the most effective way to pass illiquid assets to the next generation, contact Wescott Financial.


[ii]Based on current estate tax provisions as of October, 2017