6/ The Meek Shall Inherit Very Little
The ownership chain of every little thing can theoretically be traced to the original owner who asserted the ownership claim. What hasn’t been discussed yet is the change of property rights due to inheritance, marriage, and divorce.
Partition law in the US: a part owner of land can trigger the sale of the entire parcel to get their share in cash; since the fair price can’t always be established – the sale looks more like a fire sale with the same outcome: pennies on a dollar of value paid by a sole bidder (always a sole bidder).
What doesn’t help is that if a judge orders the land to be sold, the buyer has to be very quick to come up with cash on the spot. Selling family land (and collecting funds from heirs who may not even know they own part of that land) usually means heirs get left out.
(Rule #1: have a will and keep assets in a close family.)
Inheritance problems are very serious because after two generations it’s hard and costly to keep track of all fractional owners, who in their turn usually have conflicting views, interests, and financial needs.
An example is a vacation house: owners’ children usually get along well and use the house for family gatherings, but the grandchildren drift apart, have no need for this house as much as their parents do and would rather have their share in cash rather than a time share.
Part ownership is a curse, because the rights of the owners are limited: it’s usually not possible or substantially hard to get a loan using the part of the property as a collateral, or for the improvement of the property.
Physical partition (instead of selling for cash and splitting the proceeds) is sometimes possible if the resulting parts can be economically useful. The more heirs there are, the easier it is to sell the land and give everyone their share, as the resulting plots may be too small and completely illiquid.
The sale of a family plot inevitably means the loss of many valuable family connections and usually means lower quality of life for the elder family members.
However, rules can be made to encourage maintenance and continued co-ownership of land (Germany) instead of forced sale.
What’s interesting is that organising land ownership as a family farm corporation where the land is being formally managed by (say) an elderly member of the family, paying dividend (if any), taking loans, etc. [MK: and I presume, holding the land in trust for the distant heirs who are yet to be identified.]
The core legal underpinning for the loss of land is ages old and is the balance between governance and exclusion. In effect, the law attempts to separate ownership (this is mine, not yours) instead of finding ways to manage common property. But this is bordering socialism (collective ownership) and thus is considered unwelcome. Governance is about finding ways for a group of owners to work together for the financial wellbeing, as well as social and spiritual reasons.
An alternative is liberal commons property – the kind of ownership allowing governing scarce resources while maintaining individual autonomy.
The three trade-offs of liberal commons:
Where does the border between the individual and collective decision-making lie? (It can be as granular as a DINK family).
How will the majority deal with the dissenting views?
What are the rules for leaving the group?
[MK: this to me looks a lot like a topic of family asset management I looked at a while ago. The principles are clear, but the implementation may be very complex, and I have a feeling that the book “Mine” is oversimplifying the matter.]
On the other hand, having a group of people (at least, the 2nd generation) agree on managing a common asset does offer the benefit of making the asset more liquid and capable of being a collateral for loans.
The Death Tax
Inheritance may require heirs to pay an inheritance / estate tax. But calling it a “death tax” surely can sway the opinions of the public as well as the legislators. The fear of the inheritance tax (and the need to sell a family business) is based on the often incorrect assumption that the assets of the dying family member are likely to be in the 1% of the comparable assets.
At this moment, in the US the estate tax kicks in after $11m in assets (and $23.4m for a married couple), which in a nice problem to have for most people.
The best part is the taxation of assets with unrealised gains (say, a share portfolio). Imagine Uncle Sam having a stock portfolio currently worth $10m with $5m unrealised gain (i.e., bought for $5m and never sold). Dead people don’t pay taxes, so the heirs only pay the difference between the $10m (the “probate” price) and the price they sold this portfolio for. Yes, the $5m of unrealised gain is a nice non-taxable gift to the heirs. Clearly, this gift is only available to those who happen to be a member of the middle and upper classes.
Until the Industrial Revolution most wealth was held in land, so it was essential to establish rules about managing it and avoiding fractionation (splitting land into smaller plots). (This didn’t apply to the plots of Irish Catholics whose plots became so small that they could only grow potatoes, and in 1845 a million Irish died due to the Irish Potato Famine, and many others had to leave for the US to survive.)
Primogeniture (the oldest male heir inherits everything) was a powerful rule, leaving many heirs out – females by design and sending younger male kids to the military and the ministry.
While it looks unfair in the 21st century, many England’s wealthy families still enjoy high social status 800+ years later, and the same is (600 years) true for Florence, Italy.
In the US inheritance is not a right, but a privilege (each generation should stand on its own). It still hasn’t stopped enormous wealth accumulation in the hands of just several families in the end of the 19th century.
What corporations are to business formation and management, trusts are for families’ wealth accumulation and management. Trusts have a clear separation of asset ownership and management (with fiduciary duty towards the beneficiaries). Trusts can have an overwhelming impact on the beneficiaries making cash payments contingent on desired outcomes (even frivolous). Trusts shield beneficiaries from the complexities of managing wealth (which they would’ve had to have if they held assets directly). And, like corporations, trusts now can exist in perpetuity.
Assets held in trust don’t belong to beneficiaries and as such (in most cases) can’t be seized to settle the beneficiaries’ financial obligations.
In the coming decades baby boomers will die out resulting in the most massive intergenerational wealth transfer in the history of humankind ($30B+ of assets). Thanks to trusts, most of these assets will not be taxed.
Thus, the rich become richer not by the virtue of smart investments, but merely because of the targeted tax policies. (Indeed, sometimes earning money is easier than keeping this money.)
Making Wills and Divorcing
Having a will is a must. Having a durable power of attorney or an advanced directive specifying what can and can’t be done (medically, financially) when the person is too ill to speak for themselves, is recommended.
This also helps in the cases when children inherit (hopefully) large sums of money and are not fully ready to manage it.
There’s no room for superstitions in estate planning (which partially explains why cynical people are more likely to have their finances in order and pass their wealth smoothly).
(NY State in the past) Equal division of career success is an entitlement of marriage, so if one spouse sacrifices their career for the other spouse, in divorce they can ask for a share of their future earning potential. The injured party gets a bite at the upside, but it’s hard to administer.
(NJ state) Instead of guessing the future earning capacity, one spouse should reimburse the other one for their “investments”, plus interest. The injured party doesn’t get a bite at the upside, but it’s easy to administer.
(elsewhere) The injured party gets nothing as the decision to sacrifice the career or not is irrelevant. NY state applies this rule now. The losers are usually women (as men are thought to have higher earning capacity)
There are lots of default property rules invoked when people become married – many benefits are shared, inheritance changes, tax thresholds change, etc. Many of these default rules can be customised via a prenup in order to make clear “what’s mine and stays mine”.
In the US there are differences in state inheritance laws, and sometimes they play out poorly when property is acquired in one state, but the family moves to another state with different rules, which only apply to the property acquired while being a resident of the new state. (Hint: talk to a lawyer or an accountant.)