Ah, the sweet soft breezes of summer – they carry the sounds of your children or grandchildren at play, and they fill your vacation home with family memories that can last forever. But do you know what would happen to your beach or mountain home if something happened to you? Would it stay in your family? Could it become a burden or source of friction among your children, or could it even diminish the inheritance you leave to them by driving up your estate value subject to tax?
Factors to Consider
The question of how to insure that your vacation home can be enjoyed by future family generations is a difficult one, in part because it often entails competing interests among multiple children or other family members with regard to a cherished family asset.
Valuable properties can also drive up estate taxes if a home is treated as an estate asset, especially if it continues to appreciate in value over your entire life. On the other hand, vacation properties in areas with falling values (think of Florida for the past few years) could become an income drain on the estate if nobody wants to step in and maintain the home.
Furthermore, vacation homes in other states – if they are part of an estate – can complicate the probate process by making it subject to the laws of more than one jurisdiction. Such homes can significantly complicate the tax picture if they are located in states which have their own local estate taxes.
Legal Options to Consider
Of course, there are ways to minimize any adverse consequences associated with the probate process, estate taxes and family vacation homes. The following are just some of the options you might want to consider on a slow and cloudy summer day without more light-hearted distractions.
Lifetime Transfers. You might consider using a Qualified Personal Residence Trust to make an immediate gift of the vacation home to your children at a reduced value. This trust can permit you to retain rights over the property for a set term of years, giving your children a remainder interest with lower taxable value than an outright “fee simple” gift. Note, however, that if you or your spouse does not survive the set term of years, your beneficiaries will not be worse off, but they will not gain a tax advantage.
You could also make an outright gift to your children, designating whether they will take the property with rights of survivorship or as equal shareholders with rights to sell or dispose of their own interests. This option is being considered by many in 2012 because the generous federal gift tax exemption of $5.12 million is currently scheduled for termination by year end. Also, most states have no gift tax, but some have significant estate taxes that could apply to a home.
Lifetime gifts directly to children work best for heirloom properties that will be held by later generations. This is because lifetime gifts do not generally provide a “step up” in tax basis on a home. Thus, the heirs receiving such gifts could have a large capital gains tax bill if they ultimately sell the home (even if it is an “intra-family” sale).
Testamentary Transfers. Transfers that become effective only after you expire have the advantage of providing your heirs with a “step up” in tax basis. Thus, a vacation home that you purchased in the 1960s for $20,000 might see that tax basis rise to hundreds of thousands of dollars at the time of your death, enabling the heirs to sell it in the future without an overly burdensome tax bill for capital gains.
A testamentary transfer, like a lifetime transfer, can be made through a variety of trust entities that can help to insure a more lasting legacy. If you like, you can even fund the trust sufficiently to cover (or help with) maintenance costs or taxes. The length of the continuing trust is up to you. A trust can last for a relatively short term or can hold the property for a very long time (indefinitely in Rhode Island and for about 90 to 110 years in Massachusetts). For a period of generations, an independent trustee or family trustee(s) can manage the property or help referee disputes. Of course, as attorneys we make sure there are emergency sale provisions and other protections for the benefit of heirs.
Another popular testamentary tool is the right of first refusal. If you prefer to leave your vacation home to that child or family member who values it most, you can simply provide for a right of first refusal, pursuant to which the holder of any such right can “outbid” any competing offer for the home. Sometimes other estate assets in the “winning” sibling’s share can fund such a purchase.
Choice of Entities. Whether you plan to make a lifetime or testamentary transfer, you or your heirs should consider whether it could be beneficial for the property to be held by an entity designated for the purpose of perpetuating and protecting your vacation home legacy. Your attorney can help you decide whether a grantor trust, a nominee trust, a limited liability company, a partnership or some other entity would be best for your situation and objectives. If your vacation home can be an income producing asset when not in use by the family, then you might consider the LLC, partnership or limited partnership form of entity. Note, however, this may entail additional administrative costs.
If you can plan for disposition of your vacation home with these factors in mind, then those soft summer breezes will have a more carefree lilt and your family can go on making vacation memories for generations.
Who Needs Estate Planning and When?
For many people, the value of an estate plan will far exceed its cost due to tax savings. Furthermore, estate planning is not just for individuals who have a net worth in excess of state or federal exemptions (currently $1 million and $5 million respectively). The following people can greatly benefit from estate planning with experienced legal counsel:
- Individuals or couples who have dependents or beneficiaries with special needs;•
- Adoptive parents who need to make special provisions for inheritance that differ from state law provisions that apply to those • without a legally enforceable plan;
- Other non-traditional families, such as those of unmarried couples or domestic partners;•
- Married persons who have previous spouses or children from a prior marriage;•
- Those who have special charitable goals; and•
- Those who have ownership shares in a closely held business that could suffer grave disruption from an inheritance battle or • significant death taxes on their estates (such people can benefit from a well-structured agreement providing for life insurance on key owners in amounts adequate to fund the purchase of a decedent’s shares, according to valuations set in advance by agreement).
Furthermore, those who have estate plans should consider revising them if their life circumstances have changed due to marriage, divorce, children, births or deaths in the family, or due to significant career changes, such as a major promotion or retirement.