Remember when your oldest child saw her first jellyfish? She studied it from all angles and talked about it for days. That momentous event happened at the family beach house. It’s also where she and her fiancé announced their engagement.
While a second home may be a place you visit on occasional weekends and holidays, it’s often linked with many treasured family memories. It’s important to preserve those memories by ensuring that such a property is part of the estate planning process and stays in the family.
“What I find with vacation property is there’s more sentimental value to it than your residential real estate,” says Bill Ringham, a senior wealth strategist for RBC Wealth Management-U.S. in Minneapolis. “That’s where families tend to congregate – whether it’s a family cabin or a condo in Florida.”
But a vacation home is expensive to maintain. Sometimes parents make a decision to sell the home because of those costs without talking to their children or other family members about their plans. Another common mistake is for parents to think their children love the vacation home as much as they do and want to keep it, but that’s not always the case.
When thinking about what to do with the family vacation home, the first step should be to talk to your children about the vacation property, say RBC Wealth Management-U.S. wealth strategists. Who wants the property? Who can afford it? Will the beneficiaries get along as co-owners?
“I can’t stress how important it is,” says Catherine Walker, a senior trust consultant for RBC Wealth Management-US near Wilmington, Del. “The parents love going to the beach and assume their children do to, but that might not be their idea of fun.”
Estate planning options
Once a family has determined what they’d like to do with their vacation home, the next issue to consider is taxes. Often the tax implications will influence whether it’s possible to keep the home in the family or best to sell it.
Property left to someone in a will must go through probate – a lengthy legal process – and may face estate taxes.
Many people gift vacation homes to minimize federal and state estate taxes, says Tom Six, a wealth strategist for RBC Wealth Management-U.S. in San Francisco. Federal law exempts up to $5.45 million in assets from gift and estate taxes per individual in 2016.
In addition to federal estate tax, 15 states plus Washington, D.C., levy an estate tax, and six states have an inheritance tax. And those state exemption limits may be much lower – as low as $675,000 in New Jersey – through the end of 2016.
Given all these variables, there is no one-size-fits all approach to how a family should handle their vacation property during the estate planning process. There are, however, many options. Here are a few:
Sell the property
Parents can sell the vacation home to their children to increase their capital liquidity in their later years or as they enter an assisted living facility, says Ringham, who inherited a cabin with three siblings. In choosing this option, parents are no longer responsible for expenses or property taxes.
Establish a life estate
Parents can decide to transfer their vacation home to their children now, but continue to use it until they pass. The property still is included in the estate for tax purposes.
Gift the property
Transferring property outright to your kids as a gift will reduce the size of your total estate, but may use some of the federal exemption during your lifetime, says Ringham.
A gift that exceeds the federal annual exemption – $14,000 in 2016 – may face a gift tax of up to 40 percent. However, parents can gift portions of the property up to the federal annual limit over a number of years, Six says. In that case, the property must be appraised each year, but because the owners have partial interest, they can use tax valuation discounts. If the parents pass on before the entire property is gifted, the rest is included in the taxable estate.
Transfer the deed at death
Twenty-seven states offer a transfer-on-death (TOD) deed, or beneficiary deed, both of which have the benefit of not triggering probate. The parents don’t have to be residents of the state and the designation can be changed during their lifetimes.
Limited Liability Company
Parents can put vacation property into a Limited Liability Company (LLC). They keep at least 51 percent ownership of the LLC and designate their children as shareholders of the rest. The LLC can be dissolved or changed at any time. This is another way for parents to reduce their taxable estate. They also can add provisions to prevent an ex-spouse of a child from obtaining the asset in a divorce or deter others from going after the LLC interest, says Six. It’s important to note that pending government regulations would restrict valuation discounts on certain transfers of partial interests in property in 2017.
Trust in trusts
When determining what to do with a vacation property, families must also consider probate, the legal process through which a will is recognized and approved.
Transferring a vacation property into a trust has multiple benefits, the first of which is that by doing so, the asset will not trigger probate. But this strategy also lets parents leave property to non-family members and lets parents keep some control the property – even after death.
A trust makes sense if a vacation home is part of a large estate with multiple assets. Parents also can name a trustee – or a corporate trustee to avoid family conflicts – to manage the assets.
There are several types of trusts for families to consider:
Revocable, or living, trust
Parents can place their vacation property into a revocable trust with their kids as ultimate beneficiaries, but retain full control. This vehicle also allows them to change their minds while they’re still alive. At death, the living trust automatically converts to an irrevocable trust.
Vacation property and other assets can be placed in this trust, which cannot be altered. After death, property ownership remains with the trust and all the beneficiaries have an interest in it. “If one of three kids is sued after a car accident, a creditor can’t try to take away the property interest in the trust,” says Walker.
Some states, such as Minnesota, have created “cabin” trusts that articulate the guidelines of the use of a cabin, including rules such as payment of taxes and expenses. Beneficiaries have an interest in a cabin trust, which can pass from generation to generation, and includes money for maintenance costs for a period of time, says Ringham.
Qualified Personal Residence Trust
Parents can transfer a vacation home to this trust and continue to use it for a specific number of years. This irrevocable trust is used to reduce the parents’ taxable estate and lower the gift tax value of the home, says Ringham. If the parents outlive the trust’s term, the property will not be included in their taxable estate.
Estate planning can be difficult, especially if there are long-standing rivalries, complicated blended families or financial issues.
What if two of your four children don’t want the vacation home? What if no one does?
In that case, the estate assets can be divided equitably among family members. For example, parents may leave a $250,000 vacation house to one daughter, leave $250,000 in investments to one son and the other two children equally share the remaining $500,000 in assets.
Another major concern for parents is who will pay the taxes, insurance and upkeep on the vacation property after they die, Walker says. Parents can use life insurance (owned by a trust or payable to the trust) or designate trust assets to manage the property, she says.
It’s more complex if the vacation home is in another country, where ownership by a trust may not be recognized or where property transfers to people who aren’t citizens of that country may not be allowed, according to Six.
For example, Canada doesn’t have an estate tax, but capital gains may be due at death on appreciated property value, Ringham says. And some European and Caribbean laws limit how much of the property can transfer to a surviving spouse, he says. Before buying vacation property in a foreign country, families would be well served by consulting with a lawyer who’s familiar with the laws of both countries.
While estate planning is seldom straightforward, the decision over what to do with the family vacation home can often prove to be one of the more complex pieces of the process.
Experts advise that families with a vacation home or cabin spend time talking about whether such an asset should be handed down to the next generation, and, if so, how best to make that transfer.
This material is not intended to replace the advice of a qualified tax advisor, attorney, and accountant or insurance advisor. Consultation with the appropriate professional should be done before any financial commitments regarding the issues related to the situation are made.