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by John E. O’Grady & Katherine M. Watts

Like it or not, someday control over your properties will pass to others. You can either allow the default provisions of law to determine who will take control, or you can decide for yourself through proper estate planning. While it’s something most people don’t like thinking about, estate planning is necessary to minimize conflict between your loved ones, minimize taxes and ensure that your wishes are otherwise carried out after your death. See our article entitled, “How to Keep Your Buildings in the Family” in the February 2007 edition ofSF Apartment Magazine.

One way to ensure that your property stays in the family is to keep it in a trust for a period of years after your death before it can be sold or distributed to your named beneficiaries. Another option is a buy-sell agreement. This article examines how to use a buy-sell agreement to address certain problems that arise when property is left to siblings or other co-owners; it does not address all of the concerns typically negotiated in buy-sell or tenancy-in-common agreements.

What Is a Buy-Sell Agreement?
A buy-sell agreement is an agreement you can use as part of your estate planning. Each agreement will be different and specifically designed to effectuate your particular intent.

If you own the property by yourself, you will likely use the buy-sell agreement to carry out your wishes after you are dead. The agreement can accomplish this by putting limitations on the future sale or transfer of the real estate. Your heirs normally sign the agreement. Assuming you intend to give the property to your children, the agreement may provide that each child is allowed to sell or transfer their interest during their lifetime, but only to one of the other people named in the agreement (like your other children or grandchildren). The agreement would also provide a formula for determining the sales price. If you want to keep the real estate in your family, the agreement may provide that each family member’s will and living trust leaves the property to the family members of your choice. Additionally, due to California’s community property system, the agreement may provide that each of your loved ones must own the property as their own separate property and take the necessary steps to keep it characterized as such.

When Is a Buy-Sell Agreement Helpful?
Buy-sell agreements are useful if you plan to leave real estate to more than one person in your will and trust. They are also useful whenever real estate is co-owned by two or more people.

If you own a building (or several) by yourself, a buy-sell agreement can be essential. Consider what will happen when you die or are unable to continue managing your properties. Chances are that you have a living trust that leaves the property to your children. However, unless you have one property or other assets of equal value to give to each child, there is a good chance that your plan will have your children co-owning the buildings in conflict with each other.

Co-ownership of real estate brings a host of problems, which are magnified when compounded by inevitable sibling rivalries. Making the situation worse is the fact that, unlike most co-owners, the siblings typically didn’t ask to co-own property together. One child might not have the time, skills or willingness to do it. Another child may want to sell it and yet another may be set on keeping the property in the family. A buy-sell agreement could require one child to sell the interest to the other, at a price you established, before offering it to a third party. This allows an easy out for the child that doesn’t want to be involved, and allows the property to stay in the family in the hands of those who are willing and capable of managing it.

A buy-sell agreement is also necessary if you co-own a building with someone else. If your partner were to die, their share would likely pass to one of their family members. This person may not have the same goals for the property as you do, or the same business sense your partner did. An effective buy-sell agreement will allow you to buy out his or her interest before it is passed to someone else. It will also allow you to retain control and not suddenly be put into the position of co-ownership with someone you don’t necessarily want to own with.

Conversely, assume your partner is alive and well, but that circumstances beyond their control suddenly require them to sell or give their interest to a third party, such as a creditor. Without a buy-sell agreement, you may have no say in who they can transfer it to. You could end up owning property with someone you don’t agree with or even know. If you had an effective buy-sell agreement, you could negotiate all these factors before any problems arose. You could ensure that you had the first right to buy out their interest. Negotiating these issues before there are any problems or hardships can make the transition smoother and spare future animosity.

A buy-sell agreement can also protect your property in the event a co-owner or beneficiary gets divorced. Under California’s community property system, the property would be considered separate property if acquired before marriage or by will or devise, thus the spouse would generally have no claim to it upon divorce. However, even if the property is separate property, the nonowning spouse may have a right to be compensated for work either spouse did on the property, including management and improvements. If at the time of the divorce the owning spouse doesn’t have liquid assets to pay that compensation, he or she may be forced to sell his or her share of the property to pay it. A buy-sell agreement can require the divorcing owner to sell the share back to the other owners before offering it to a third party.

A buy-sell agreement can solve many problems involving co-ownership of real estate; however, it can create more problems than it solves if not properly prepared. To minimize hardships and conflicts that may arise, it is imperative that you carefully consider the financial implications of a buy-sell agreement.

Valuation
Death, incapacity and bankruptcy of a property owner commonly call for a buy-out. The first major consideration is the valuation of the share that is to be bought or sold. Since the market is constantly fluctuating and you don’t know when the agreement would come into play, it is advisable to decide on a formula for deciding the value, rather than setting a specific number.

Because there are many ways to value a property, it’s important to discuss the alternatives and decide on one at the outset. For real estate, it’s common to name an independent appraiser in the agreement who will determine the fair market value of the share to be sold. The parties then agree to defer to the appraiser’s determination. Keep in mind that this figure will be lower than you may imagine. For example, if you and a partner each own half, the fair market value of that half will be less than half the value of the property because a buyer in the open market will pay substantially less to be a co-owner. Valuation can be more difficult if the asset isn’t real estate. If the asset is a business, it is common to value it based on the average net income of the business. For example, the purchase price could be four times the average net income of the business over the past three years.

Payment Terms
A buy-sell agreement is ideal if you and your partner want to agree not to sell. This can be done by setting the terms of the buy-out to be highly unfavorable to the selling partner. Consider the schedule for payment. It’s likely that the value of the property is significant, and that the person purchasing it doesn’t have the money outright. To avoid conflict, the agreement may set out how much money is due at the outset, and make provisions for how many installments will be due.

Keep in mind that a buy-sell agreement is only one part of your estate plan and that other documents and actions are required to take care of your loved ones. Proper estate planning now can go a long way to ensure that your hard-earned property goes to your loved ones on your terms and nobody else’s.

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The opinions expressed in this article are those of the authors and do not necessarily reflect the viewpoint of SFAA or SF Apartment Magazine. The information contained in this article is general in nature. Consult the advice of an attorney for any specific problem. John E. O’Grady and Katherine M. Watts are with O’Grady Law Group, APC, in San Francisco and they can be reached at 415-986-5000 or see www.ogradylaw.com. Copyright © 2007 by SF Apartment Magazine. All rights reserved.