If you haven’t yet given thought to what will happen to your vacation home (or other real estate) once you’re gone, please read this!
Mere ownership of real property can trigger not-so-pleasant things such as creditor claims, unnecessary probate, additional tax, and most importantly – ugly family disputes.
Whether it’s a cabin in the woods, a chalet on the mountain, or a cottage by the sea, a family vacation home is the getaway that brings everyone together – a place to make memories.
But at some point, sooner rather than later, you’ll need to think about passing along your property. As you get older, there may come a time when you no longer feel up to managing the place. And at the end of your life, you will want to leave instructions for what should be done with it.
It’s nice to think about future generations enjoying your special place, but you need to give careful consideration to the different ways of keeping your family vacation home in the family. The best place to start is a conversation with the relevant parties, usually your children. Start by asking if they have interest in eventually owning (and maintaining) the property. Many families have run into trouble when parents either assume that their kids aren’t interested (and sell the property without any notice), or assume that their kids are ready and willing to take on the responsibility (when they either aren’t or don’t want to).
Assuming that your children would like to take on stewardship of the vacation home, the next step is to figure out the best way to make that happen. There are a number of options, and no one right way to handle such property during the estate planning process. The method you choose will depend on your ultimate wishes and your specific situation.
Make a clean break: Sell the property outright.
You can sell the vacation home directly to your children. This is a straightforward solution that increases your capital liquidity (which might be helpful) while freeing you from the burden of property taxes and maintenance expenses.
Have your cake and eat it too: Establish a life estate
In this scenario, you transfer the home to your children now, but are able to continue using it for the duration of your life time. Remember, however, that in this case the vacation home will still be included in your estate for tax purposes.
Let go gradually: Gift the property over time
If you’re not concerned about reaping any financial benefits from the sale of the property, you can gift it to your children. To avoid gift taxes of up to 40%, you can gift portions of the vacation home (up to the federal annual limit) over the course of multiple years. This does involve a little extra work with yearly appraisals, but you can use tax valuation discounts.
Take the formal approach: Establish an LLC
A Limited Liability Company (LLC) can be used to both reduce your taxable estate and give your children partial ownership of the home. So long as you retain a majority of the ownership―at least 51%―then you can designate the rest to your kids while retaining the ability to make all of the important decisions about the property. LLCs are fairly flexible; they can be dissolved or updated at any time. They are also a good way to protect your family vacation home from falling into unintended hands. For instance, the LLC could include a provision that keeps any ex-spouses of your children from making any claim for the property.
Avoid probate: Go with a trust
You can use a professional or personal trustee (a professional one can often help avoid internal family drama). There are three primary types of trusts:
- A revocable (or living) trust allows you to maintain full control of the property while designating your children as the ultimate beneficiaries. The nature of a revocable trust allows you to make changes at any point.
- An irrevocable trust, on the other hand, cannot be altered; and after you’re gone the property remains in the trust rather than passing to your kids. This arrangement helps protect the property against any claims from creditors.
- A qualified personal residence trust (QPRT) allows you to transfer the property into a trust, but continue to use it for a predefined number of years. This type of trust will reduce your taxable estate and lower the gift tax value of the home, but timing is of the essence. If you outlive the terms of the trust, the property is passed to your children. If you die before the end of the QPRT term, however, the property reverts to your estate and is subject to the terms of your will.
An additional benefit of most trusts is that if you owned out-of-state real estate in your name, your passing will trigger a frustrating and expensive “ancillary probate process.” This is a process that involves a second probate court (in addition to one taking place in the state where you died). Putting a family vacation property into a trust is a good strategy for avoiding this additional probate process.
Keep things simple: Sell the property, and split the proceeds
If all of the above approaches sound like they might lead to unintended strife between siblings, there is an even more straightforward way to handle vacation homes and other property in your trust. You can simply stipulate that, upon your passing, all properties are to be sold at market value, and the proceeds from the sales split equally between your children. Depending on the nature of sibling relationships in your family, this may be the kindest and most sensible approach to providing a fair solution.
Many Options. One Starting Point: Honest and Open Conversations
However you decide to handle your vacation home, if you decide to keep it in the family, it’s a good idea to have a frank conversation with everyone involved. There are a lot of variables involved with managing, caring for, and using a vacation home if you have more than one child. For instance…
- Who will be allowed to use the home and when?
- Who will be financially responsible for maintenance and other upkeep?
- Who will be responsible for coordinating that care?
- How will siblings decide when certain capital projects (a new roof, for instance) need to be addressed?
- Who will carry insurance and what will the coverage include?
- Can any sibling sell or transfer their interest in the property?
It can be wise to not only discuss these questions, but to also draft up a written agreement that outlines the expectations and so forth. After all, your vacation home is a place for fun and fond memories. You don’t want it to become a source of anxiety or conflict.
And trust us – we’ve seen far too many families torn apart, fighting in court because there were no clear instructions in place for handling real estate, especially after one passes. It’s heart breaking.
Whether you want to avoid family strife, probate, tax or potential creditor issues, you really must include instructions for how you want your real estate to be handled. And you really should do it now. Give us a call and we’ll help guide you through it.