This is Rick Harmon and welcome to the Gordian Knot show, where we talk about probate trust and real estate ownership messes in California. This is episode 18. We’re going to be talking about fractional interests, and I want to share a few ideas with you, some of my experiences of past years, and how you can break up the ownership interest of a property, and not just into 50-50, half and half, but holes in donuts and all kinds of wild ways of looking at this that has actually been brought to us.
So, I’ve got to start this out with a little bit of an explanation. I knew I was never cut out to be an attorney and never had any interest in doing that, nor has tax work ever been something that’s ever been near and dear to my heart, but the messes that people have brought to me over the years, and I started in 1978. These messes have just never stopped. Why? Well, it’s probably because I attract them, and the reason I attract them is because I love solving these kinds of puzzles. I like working with attorneys. I like working with the experienced real estate people, but particularly I enjoy it when people bring me messes and they’re a little overwhelmed, and there is a solution, as long as it’s in California where I’m really familiar with title law. A lot of people don’t understand that even though I’m best known as a probate expert, I’m actually a title expert masquerading as a probate expert for the last 30 years in that particular market.
So, a few thoughts on fractional interests. It’s not unusual for someone to bring a client to me or to refer me a situation where two or more people are on title. Now, it’s not a big deal when John and Mary are on title as husband and wife, joint tenants as an example, and then one of them dies and then they file a affidavit death of joint tenant and the surviving spouse typically now owns the property. The last spouse, if they’re both deceased, there’s probably it’s going to become a probate.
But what if John and Mary are brother and sister and they own the property as tenants in common, or at least with no one in California, and unless it’s described in a court order otherwise, it’s most commonly described as just John and Mary and not designated that there are a tenants in common, not designated their relationships. That’s not unusual. Mary lives in the property. John owns his one-half share and he’s not receiving any benefits. He might even live out of state. They might even have a relationship that’s strained. John doesn’t have any way of doing anything with that because there’s not a lot of people who want to buy a half a house, let alone a half a horse or half a car or half of anything else.
So the solution that we’ll see is usually some way for John to get liquidity from his interest. Or sometimes if there’s an open probate, it’s not unusual for us to work with this, as we will make a loan to an open estate or to a trust where one of the parties is the successor trustee in an irrevocable trust and then we go forward to provide the liquidity necessary.
Now, what if there is something unusual, like a life estate? Well, the way I like to describe a life estate is if John is actually living in the property and Mary is going to receive the beneficial interest after John passes away, I like to describe that as being a donut and hole in the donut description problem. So what we have now is if you can imagine a property and the total estate or asset is owned by John and Mary collectively, the problem now becomes is that Mary has no way of receiving any benefit at this time. If John is the life estate holder, presumably living in the property, then John gets the benefit of having a place to live and hopefully maintaining the property. Mary, of course, is left out in the cold, and unless there’s terms to the contrary, the only way that Mary is going to get any benefit is when John leaves the property, presumably after he passes.
Our solution in dealing with a situation like this has typically been if someone needs liquidity, since it’s not practical to borrow on either the outer ring or the donut or the tenancy that occupies the property. We’ve tried to take it in total and we’ll find a way for example, of leaving a property in the trust typically, or in an estate, typically either one where we have 100% of the property and then we can make a loan to the total and then distribute the property subject to that loan. Now this is when we’re doing a probate or trust or otherwise type of private money fiduciary mortgage.
Not everybody wants that. There have been plenty of cases where John and Mary inherited a property and one of them is to live in the property and then they have the issue of multiple generations or second marriages that further complicate matters. So, if we step back and look at the picture in total, we want to say, okay, with these fractional interests, who is receiving all the benefits now and who wishes to receive benefits who is not and what can they do? So the one who is not receiving any benefits most of the time would like to be done with this. So since there’s no real ready market for people wanting to buy fractional interests with a property that they can’t receive any useful benefits out of it, what other ways of structuring these types of sales?
And one of the ways is to sell the property. But most of the time both parties don’t want to, can’t agree on anything. So this isn’t going to turn into a partition action, which ultimately is going to force an option. But absent that, a more attractive way to work this sometimes is to just sell the fractional interests and then have that party who is the new buyer who stepped into the other person’s shoes, is to go back to the owner of the dominant share that’s living in the property and work something out where they can use either private money or a reverse mortgage or if they’re old enough or even a way to do seller financing, like in the old days, basically carrying a note and a deed of trust on the entire asset, but actually just keeping the note value at whatever they agree to.
Pretty simple to do and the documentation is pretty straight forward. This way the other person’s able to sell the property or if they just end up with the note, they can sell the and let someone else have to do the heavy lifting, even if that does end up being a partition action. But the key is to find some kind of an attractive way to make a individual who doesn’t want to own a piece of property receive some kind of benefit, particularly if the other one is not cooperative and let someone else who’s a professional be the person who’s going to facilitate this.
We see lots of messes, lots of fractional interest, lots of pieces, lots of parts that are subject to all kinds of other issues. So again, going back to several episodes ago where I described my PETITO, formula, property, equity, title, interest, threats and opportunities, it’s one of the easiest ways of laying out what the issues are and describing it to a third party. As a legal professional or real estate agent or broker, it’s really imperative that you have a way of describing this to other professionals so they can best assist your client.
This episode is brought to you by closeprobate.com, loans and solutions for cash poor California estates and trusts. You are listening to the Gordian Knot with Rick Harmon.