Selling a Parent's Rental After a Dementia Diagnosis: Capacity, Power of Attorney and the Exchange

A diagnosis is not incapacity, so first find out what your parent can still decide

State law starts from a presumption of capacity. California's version is typical: Probate Code section 810 presumes that everyone can make decisions and says a person with a mental disorder may still be capable of contracting and conveying property. Under section 812, a person lacks capacity for a decision only if they cannot communicate it or cannot understand its rights and duties, its probable consequences, and its significant risks, benefits and alternatives.

Early in a diagnosis, many parents can still sign a listing agreement, a sale contract and an exchange agreement, or at least a power of attorney. A letter from the treating physician about decision-making ability, dated close to the signing, protects everyone if the sale is challenged later.

If capacity is already doubtful, do not ask your parent to sign. A deed or contract signed without capacity can be challenged, and a title company may refuse to insure it.

Line up the people early: the listing agent, the qualified intermediary, the title company and the CPA should all know who will sign and on what authority before the property is listed. Each may ask for the power of attorney or trust certification in advance, and a missing page discovered at closing can push the sale past the date a buyer will wait.

Who can sign instead: agent, trustee or conservator, in that order of speed

A durable power of attorney is the fastest route. Probate Code section 4124 defines one as a power stating it is not affected by later incapacity, or that it takes effect on incapacity. Read it for real estate authority and check its limits: under section 4264, an agent may create or change a trust, make gifts, or change survivorship interests only if the document expressly says so.

If the rental is titled in a revocable trust, the successor trustee usually takes over under the trust's incapacity clause, often on physician certification. In California, section 15800 then requires the trustee to give beneficiaries notice and a copy of the trust within 60 days of learning that no one holding the power to revoke is competent.

Without either document, a court conservatorship or guardianship of the estate is needed. Under section 2540, a conservator's sales of real property are subject to court authorization, confirmation or direction, which adds hearings and time. Other states use different names and procedures; a local elder-law attorney confirms which applies.

The parent stays the taxpayer, which keeps the exchange and the step-up intact

An agent or trustee signs on the parent's behalf, but the seller for tax purposes is still the parent. With a revocable trust, section 676 treats the grantor as owner of a trust they can revoke, so the trust's sale and purchase are the parent's exchange. Title the replacement in the same name as the property sold: the parent, or the same trust.

That matters because of the step-up. Section 1014 sets the heirs' basis at fair market value at death. Gain deferred through an exchange stays inside the replacement and disappears at death; gain taxed in a cash sale is gone for good. When life expectancy is limited, selling for cash can turn a tax that would have vanished into one that is paid.

Do not let anyone retitle the replacement to a child to make management easier. That is a gift, it needs express authority under most powers of attorney, and it gives up the step-up because the child takes the parent's basis.

Worked model: a $700,000 rental, a parent in memory care and two ways out

Hypothetical round numbers. Your parent's rental is worth $700,000 net of selling costs, with an adjusted basis of $200,000, so the gain is $500,000. You hold a durable power of attorney with real estate authority. Run your own numbers with your CPA.

• Cash sale: the $500,000 gain is taxed in the year of sale, including the depreciation layer at up to 25%. The rest is available for care, but the tax is permanent.
• Exchange into DST interests: the $500,000 is deferred, all $700,000 stays invested, and no one has to manage tenants. At death, the heirs' basis resets to the interests' value then.
• Split: take enough cash at closing to fund care and exchange the rest. The cash is taxed as boot up to the gain; the remainder keeps its deferral and its step-up.
• Whichever route you choose, keep a written record of why it serves your parent's interests; agents and trustees owe duties to the person they act for.

Why a DST is often the low-effort replacement, and what it gives up

A DST suits a parent who can no longer oversee property, and an agent who does not want to become a landlord. The sponsor's manager runs the property, distributions come to the parent's account, and Rev. Rul. 2004-86 lets the interest count as real property for the exchange.

The trade-offs: distributions are not guaranteed, the interest cannot be sold easily if care costs rise faster than expected, and the agent has no control over the property. Keep a cash reserve outside the exchange for care. Elderly parent 1031 options, moving into assisted living and DST illiquidity and exits cover the planning around it.