As a financial professional, it is essential to provide informed guidance to clients who are beneficiaries of an estate. In some cases, beneficiaries may not realize they have the ability to sell their interest in the estate prior to final or interim distribution. Clients may seek this opportunity when estate settlements are prolonged or when the clients require liquidity.
However, selling an estate interest is not a straightforward transaction, and beneficiaries must carefully consider the implications, which can include receiving a discounted value compared to the final distribution and losing potential future income or appreciation from the estate.
This article provides practical considerations for beneficiaries who are contemplating or seeking to sell their interest in an estate, and offers insights into how financial advisors can help them navigate this complex process.
Understanding estate interests and the sale of beneficial rights
An estate interest is the beneficiary’s right to a share of the assets or income of the deceased’s estate. During the estate administration process, the beneficiary typically has no direct control over specific assets, but they may have a right to the proceeds or distribution when the administration is complete. The sale of estate interests typically falls under provincial law governing estates and trusts. The specific legislation may vary from province to province; regardless, the following items are critical to understand:
Assignability. If the beneficiary’s interest in an estate is assignable, the beneficiary can transfer their right to receive their share of the estate to another party. However, the sale or assignment must comply with provincial estate law and any relevant provisions in the will and trust document.
Will. Some wills contain restrictions on the transfer or assignment of beneficial interests. In such cases, the terms of the will must be reviewed to determine whether a sale is legally permissible.
Notice to estate trustees (executors). When a beneficiary sells their interest, the estate trustee (executor) must be notified of the assignment. This allows the trustee to ensure that any distribution is made to the correct party.
Given the complexity of estate laws, financial advisors should collaborate with legal professionals to ensure that beneficiaries fully understand their rights and obligations under provincial law before proceeding with the sale.
Valuation of the estate interest
Another critical aspect of selling an interest in an estate is determining value, and understanding the valuation methods and factors that can impact the amount the beneficiary receives. Some important considerations include:
Nature of the estate assets. Estate assets can vary, from cash, securities, shares in a private corporation and interest in a trust to real estate and personal property. The type of asset significantly impacts the ease and timing of distribution. For example, real estate and personal property may take longer to liquidate, affecting the overall timeline of estate administration and the value of the beneficiary’s interest.
Number of beneficiaries. The value to which the beneficiary is entitled may depend on the number of beneficiaries with an interest in the estate.
Distribution timing. Estates can take months or even years to be fully administered. If there are delays, such as disputes among beneficiaries or the need to sell illiquid assets, the timing of the final distribution can be uncertain. This can lower the perceived value of the estate interest, as buyers often seek a discount to compensate for the risk and delay.
Liabilities and taxes. Any debts, liabilities or tax obligations of the estate will reduce the amount available for distribution to beneficiaries. These obligations must be considered when valuing an estate interest.
Discounted cash flow. A common method to value the estate interest is using the discounted cash flow (DCF) approach, which estimates the present value of the expected future distributions from the estate, adjusted for the time value of money, risks and uncertainties involved in the estate’s settlement process.
Beneficiaries should be aware they are likely to receive less than the full market value of their interest due to the inherent uncertainties of the estate administration process. Buyers typically discount the price to account for the time lag and risks associated with the estate’s assets, liabilities and potential legal disputes.
Client example
Leah is a beneficiary of her late mother’s estate, which includes real estate holdings and investment accounts. Leah is entitled to 30% of the estate’s after-tax value, which is estimated at $600,000. However, due to complexities in asset liquidation, the final distribution is expected to take three years.
Leah needs liquidity and decides to sell her interest now to the other estate beneficiaries. Her financial advisor uses the DCF approach to estimate the present value of Leah’s 30% share, applying an agreed upon 10% annual discount rate to account for time value, risk and potential delays in distribution.
Leah’s share of the estate is $180,000 (30% × $600,000).
Since the $180,000 distribution will occur only at the end of three years, we apply the three-year discount factor (10%):
Present value = $180,000 × 0.751 = $135,180
Thus, under the DCF approach, Leah’s interest is valued at $135,180 today. This valuation provides a basis for negotiating with the other beneficiaries.
Identifying potential buyers
Finding a buyer for an estate interest can be challenging, as this market is not widely developed in Canada. Potential buyers include private investors, family members or other beneficiaries, and specialized investment companies.
It is essential for the beneficiary and their financial professional to conduct due diligence on potential buyers to ensure that the transaction is conducted in a reasonable manner and that the beneficiary receives a reasonable price for their interest. This involves working closely with legal and tax professionals to ensure that the transaction is structured in the most advantageous way for the beneficiary.
By helping beneficiaries navigate the complexities of selling an estate interest, financial advisors can provide valuable support during a challenging time, ensuring that clients make informed decisions that meet their financial needs.
Michael Kulbak, MBA, CPA, CMA, TEP, is principal of Kulbak Trust Solutions in Mississauga, Ont.