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Let's say there's the following scenario. A couple who are homeowners and parents of three adult children build a small, one-story detached mother-in-law cottage (500 sq. ft.) with kitchen and bathroom on their existing property. They then sell the exact same property (where the cottage is located) to the oldest adult child for the fair market value of the previous home and property (so minus the cottage, which they spent $200k on). In other words, let's say that as a property without a cottage on it, it would have sold for $750,000 and that was the price the oldest adult child paid. They didn't incorporate the cottage value into the sale price.

Next, they live in the cottage the next 25 years rent-free while the oldest adult child lives in the main home. After 25 years, they pass away.

They leave their estate "equally" to the three children. The estate at this point consists only of cash and investments.

The two younger children contend that the mother-in-law cottage on the property should be considered as part of the oldest child's inheritance. After all, the oldest adult child only bought the property and the main house. The younger two children believe that if the parents' assets are split three ways between all of them equally, the overall split is unfair, since the oldest child now receives a cottage on their property on top of the 1/3 split of the cash + investments. They point out that the oldest child can rent the unit out to generate income, or if the oldest child sells the property, they would receive a profit over and above the original value paid due to the presence of the additional unit, which they didn't pay for in the original home purchase price.

If they all agree that they should offset this additional gain to the oldest child, what is a fair, scientific way of valuing the extra unit?

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  • Whose name was the cottage in? Was it not a separate deed, but part of the main house property? i.e. One parcel of land with two living units?
    – JTP - Apologise to Monica ♦
    Feb 14, 2018 at 0:14
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    My understanding of "mother-in-law cottage" is a separate dwelling on the same piece of land. They generally cannot be conveyed separately from the main house.
    – Rupert Morrish
    Feb 14, 2018 at 0:19
  • @JoeTaxpayer Yes that's right: it was not on a separate deed. It was part of the main house property. There was only ever one parcel of land, that had two living units (entirely separate buildings) on it.
    – Seattle Part 2
    Feb 14, 2018 at 15:58
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    This needs to be clarified in the will itself. Settling disputes between siblings due to unclear last wishes is a gigantic source of family-ending conflict. Whatever the parents decide and write in the will, is the way it goes.
    – Grade 'Eh' Bacon
    Feb 14, 2018 at 17:01
  • Was the cottage built with all appropriate permits, inspections and is an allowed use under the zoning, or is the next sale to someone unrelated to this family going to uncover a (potentially expensive to correct) surprise?
    – user662852
    Feb 14, 2018 at 17:04

3 Answers 3

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You should value the unit at:

The fair market value of the whole property in 1983 (or whenever 25 years ago was)
minus what the eldest sibling paid for the whole property
minus the expected value in 1983 of free rent to the parents for the rest of their lives,
Then convert from 1983 dollars to 2018 dollars.

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  • This feels like a long comment. You summarize the question and ask a question of your own, which is an appropriate short comment.
    – JTP - Apologise to Monica ♦
    Feb 14, 2018 at 0:58
  • Thanks, @JoeTaxpayer. I have tried to turn it into an answer.
    – Rupert Morrish
    Feb 14, 2018 at 1:13
  • To clarify what do you mean by "minus what the eldest sibling paid for it" ? In a way, the eldest sibling didn't pay anything for it. Nothing that has a solid receipt. In another way, they paid extra taxes and insurance over the years, repairs, the opportunity cost of rental income, and some level of depreciation on the cottage since by the time it was in their possession, normal wear and tear of the building materials would degrade the flooring, roof, appliances, fixtures, heating, plumbing, etc.
    – Seattle Part 2
    Feb 14, 2018 at 16:00
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    @SeattlePart2: You wrote in the OP: "They then sell the exact same property (where the cottage is located) to the oldest adult child for the fair market value of the previous home and property". That's what the oldest sib pair for it.
    – Rupert Morrish
    Feb 14, 2018 at 19:28
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The cottage belongs to the owner of the main home. It was not left when they passed. The other assets are part of the estate and should be split via the will.

If as you suggest, for some reason they all (i.e. the house owner esp) wishes to include it. I could make the claim that it has no value separate from the main home as it can't be partitioned. Will the homeowner rent it out? If not, the cottage is an expense, they'll need to pay tax on it, keep it in good repair, and pay the utility bills. If they rent it out, I'd look at the rental net income, after all costs, and assign a multiple of that, say 10. So a net $12000 income is valued at $120K.

Another way is to simply multiply the size, square footage of the cottage, and multiply by the average local home value cost/sqft adjusting for land value.

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If the cottage was built with permits, as you say, the property was re-assessed at the time it was built, presumably with a substantial increase in value attributable to the cottage. You can use that to decide what percentage of the total current valuation (use Zillow or Trulia for a rough estimate) is from the cottage. This won't work if the sale to the children was recorded and the re-assessment for the new construction was overridden by a re-assessment triggered by a sale (at an artificially low price), which would be a subterfuge to avoid property taxes.

How to account for 25 years of free rent depends on its value in your particular neighborhood.

I'm sorry your parents did not think about this inequity while they were alive.

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