Many California trust and estate disputes involve the allocation of real estate amongst several beneficiaries. Mom and Dad, may they rest in peace, owned an upscale home in the Fab 40s neighborhood of East Sacramento, a sweet Tahoe vacation home, and a few rental duplexes, but did not specify how these assets were to be split between their children. The daughter and/or son tapped to serve as successor trustee has to sort it out.
A trustee in California commonly has discretion to sell real property (the legal term for “real estate”), distribute it out to all beneficiaries in equal shares, or allocate it to one or more of them. The beneficiaries, however, can object to the proposed distribution. Trust and probate administration can grind to a bickering and litigious halt. How do such conflicts over real property distribution unfold?
If a parcel of real property is distributed “pro rata” to two siblings who have equal remainder shares in a California trust, each will receive a one-half undivided interest in the property, generally as a tenant in common. In a pure pro rata distribution of assets, the siblings each would receive a half interest in every asset distributed from the trust or estate, net of the administrative expenses that get paid first.
Such pro rata distribution may set the stage for conflict. Tenants in common share the right to enjoy the property, but how will they allocate the use? Who gets Christmas week? What renovations should be done and are the co-owners equally able and willing to contribute to the expenses? Who will handle paying the bills? Even if the beneficiaries start on the same page, what will happen as they get older and their shares pass to subsequent generations?
The other form of allocating assets is non pro rata distribution. Instead of the beneficiaries receiving an equal interest in each asset, they receive a proportional share of the total value of all assets. Thus, for example, the sibling who most wants the family home may receive it while the other gets corresponding value from the brokerage account. They can then go their separate ways without asset co-ownership.
For assets held in a trust, California Probate Code section 16246 generally authorizes a trustee to choose how to distribute assets. The trustee may “effect distribution of property and money in divided or undivided interests and … adjust resulting differences in valuation.” A distribution of non-monetary assets “may be made pro rata or non pro rata.”
Similar authorizing language is often written into trust instruments, which reinforces the trustee’s power to make a non pro rata allocation.
With respect to assets held in a probate estate, California law also permits a court-supervised allocation of assets on a non pro rata basis. Under Probate Code sections 11950-11956, when the beneficiaries do not agree on a plan of distribution, the personal representative (e.g., executor) of the estate, or any beneficiary, may petition the court to allocate the assets. Any such division of property must be equitable, under section 11950, and leave each party “with a value proportionate to the value of the party’s interest in the whole,” per section 11953.
While allocating real property to one beneficiary instead of all may avoid future co-ownership conflicts, it’s often a struggle to get all beneficiaries on board with a non pro rata allocation.
More than one of the eligible beneficiaries may want a property. In addition to sentimental attachment, the property (thanks to Proposition 13) may have a low assessed value for property tax purposes. Consider our two child scenario above. Child A, who gets the parents’ residence, may enjoy an assessed value that is a small fraction of the current fair market value while Child B who uses brokerage account assets to buy a house across the street will pay property tax based on the full purchase price. As the years pass, Child A will have much lower carrying costs on his house than Child B will have on hers.
Another major hurdle with non pro rata allocation is asset valuation. Real property is commonly appraised as of the pertinent party’s date of death, but many months or even years may pass before the property is actually distributed out to the beneficiaries. A reappraisal might be needed to determine current fair market value and the interested parties may choose to commission their own appraisals. Also, many properties have unique attributes that may undermine confidence in the appraised value.
If the fiduciary (e.g., trustee or personal representative) is also beneficiary, as commonly occurs, any non pro rata distribution proposal may be questioned as self-serving. Why, for example, should the trustee get the rental duplex that was renovated recently and is a steady source of income?
In the absence of a written agreement between all interested parties on a proposed non pro rata distribution, the proponent will need a probate judge to approve the plan. As to trusts, Probate Code section 17200(b)(4) authorizes the judge to determine “to whom property shall pass or be delivered … to the extent the determination is not made by the trust instrument.”
A dispute over whether a non pro rata distribution of property should occur may require an evidentiary hearing as to valuation and equity. While the law empowers judges to mix and match what beneficiaries receive from trusts and estates, they will encourage beneficiaries to attempt to find common ground through mediation or other negotiated agreement. If the parties can’t agree, they run a risk that the judge may choose to direct the sale of the property instead of awarding it to any of them.
Mom and Dad can avoid a fight over the real property they will leave behind by specifying who gets what. For example, if they have done well in Monopoly, they may decide to distribute Boardwalk to Diana while giving Atlantic Avenue and Marvin Gardens to Sonny. Yet locking in such distributions may lead to substantial inequities as the years pass and what if they need to sell Marvin Gardens to pay for their living expenses?
If the children end up with equal remainder interests in real estate, they should (preferably with the assistance of attorneys and tax advisors) attempt to work out a cooperative plan of distribution so that “rough justice” is achieved in terms of proportionate value and they can choose with whom and under what terms to co-own properties.