Family Vacation Homes

By Martin M. Shenkman, CPA, MBA, JD

Vacation homes are a common family asset, but keeping them in the family for successive generations, while keeping the peace, is not always an easy task. You have to address gift and estate tax issues on making the transfer, funding carrying costs, and family issues (who gets to use the house this Christmas?).

 

There are lots of ways to structure gifts or bequests of farms, second homes, vacation or similar properties to your heirs in a manner that keeps them in the family. (Keeping everybody happy is a different story…) Here are a few:

 

Revocable Trust – A revocable trust is "revocable" in that you can change, modify or "revoke" it at anytime. The benefit most often touted for revocable trusts (sometimes called living trusts or living trusts) is that they can be used to avoid "probate". Probate is the formal process to have a will admitted or recognized by court and to have your estate administered (collecting assets, paying expenses, and then distributing assets to beneficiaries). Using a revocable trust will not affect a current transfer of the property, but it can avoid probate and assure the desired disposition at a later date (e.g., it would prevent an agent under your durable power of attorney from selling or transferring the house).

 

Simple Gifts – If your vacation home is not that valuable, or if you have a large family, you might simply gift the house to your heirs using the annual $12,000 gift tax exclusion. The simplest way to accomplish this is to have a deed prepared that reflects the ownership percentages after each gift. Example: You own a vacation condominium worth $300,000. You have 5 children, each of whom is married. You and your spouse can each gift $12,000 worth of the home to each of 10 heirs, or $240,000 in one year. Your real estate attorney could revise the deed to reflect (ignoring discounts) each heir owning 8% of the condo. Next year, you and your spouse gift the final interests and a new deed would be prepared reflecting each of the 10 heirs owning 1/10th of the condo.

 

General Partnership (GP) or Limited Liability Company (LLC) - Gifts that are made over a longer duration could cause the deeds to become too cumbersome. Local transfer taxes or fees are costl, and minor children cannot own real estate directly under state law. If this is the case, think about having a simple GP or LLC own the property. This strategy allows you to divide up the ownership interests of the entity, rather than using a deed each year to accomplish the transfers. These approaches can provide control mechanisms as well. The general partner of the GP or the manager of the LLC can control decision making for the property. Example: You could name your two children as managers so that all decisions rest with them, not their descendants.

 

Qualified Personal Residence Trust (QPRT) – This is a trust designed to gift your home or second home to children, but not to grandchildren. The QPRT technique provides significant leverage to the transfer because, for gift tax purposes, the value of the house is reduced by the right you retain to live in it during the trust term. Example, you gift a $1 million vacation home to your four children using a 15 year QPRT. You’re age 65. You have the right to use and live in the house for the next 15 years after which your children will own it. The value of the house is reduced to about $260,000 for gift tax purposes. Further, if the house appreciates at 4%/year it will be worth about $1.8 million when the children receive it. This technique is a great gift tax leverage. However, unlike the dynasty trust the house will not pass to future generations unless your children decide to do so (e.g., after your 15 year QPRT ends, your children can choose to QPRT the house to their children). If you only want to get your house on to the next generation, this is a great technique.

 

Dynasty Trust – You could establish a long term trust (or, if your state permits, a perpetual trust that continues forever) to hold a family vacation home for future heirs, including grandchildren and later generations. The trust documents would include provisions governing use of the house (e.g., no pets, no smoking, strict limitations on sale, rotational systems (which child’s family gets the house on which Christmas, etc)). Investment provisions would have to be included in the trust document to permit the trustee to have most of the trust wealth comprised of a single asset, not have to diversify, and express permission to hold non-income producing assets. Carefully plan how the trust will meet expenses of the property. The simplest approach may be to gift or bequeath sufficient cash to the trust to meet expenses, but this does not provide much leverage for gift or estate tax purposes (e.g., no discounts). Even if cash is contributed, consideration should be given to permitting or even requiring the trustee to charge heirs for certain expenses, or a modest usage fee.

 

In addition to the structure of the gift, there are a host of other issues you must address when transferring a family vacation property to your heirs. The following are a few:

 

Agreement – To minimize the likelihood of disagreements, you should have a written agreement addressing as many issues as possible. If you are planning a gift of a vacation home to your heirs, complete the agreement and have it signed as part of the gift process. For example, if you are making simple gifts using a GP or LLC, then the partnership or operating agreement for the entity can include the rules governing the use and operation of the property. If you are gifting the vacation home to a trust for your heirs, the trust document could include operational rules. If your parents have already given the house away to you and your siblings, you should all work together to get an agreement in force before you really need one (then it’s too late!). If there is an issue you all cannot agree on, focus on the positive and agree on everything but those thorny issues. At least other problems can be avoided. Often, building consensus on lots of other issues helps resolve the previously irresolvable issues. You and your siblings could form a GP or LLC and create a simple agreement to govern usage, funding costs of repairs, etc.

 

Agreement Details – What should be addressed in the agreement? While specifics will vary depending on the property, family, use and other factors, consider the following:

o Who can use the vacation home and when? Example: Your daughter and her family can use the home for Christmas in even years. Your son and his family in odd years.

o Allocation of costs. Who pays for what? Example: Each child could contribute a pro-rata share for taxes and interest. Other expenses could be allocated by the number of days each family uses the property.

o Who decides if an improvement is to be made? Perhaps the managers or a unanimous vote of all family members of the senior generation (e.g., your children only, not grandchildren) can decide.

o Smoking, vegetarian kitchen facilities, and other personal matters of importance.

o Who chooses decorations and furnishings? Who pays for them?

o Who can make legal decisions (e.g., appeal a property tax assessment)? This could be handled by a person or heir designated by you, or elected by the heirs generally.

o What insurance coverage should be maintained?

o Can an interest be sold? At what price and to whom? Should buyout provisions be included in case certain family members don’t get along?

o Are pets allowed? What if a family member has allergies?

o Who is allowed to use the home? Step-children? Unmarried partners? Ex-spouses? Friends? Your frat brothers?

 

Conservation Easements – These can be used to maintain the property as it is, and to lessen the value for transfer tax purposes, making the gift of the property to your heirs less costly. You might be able to donate the development rights to a qualified charity, exclusively for conservation purposes, and receive a current income tax deduction. IRC Sec. 170(h). This can be achieved by adding a permanent deed restriction on the development of the property. This could be an easement given to the qualifying charity that preserves natural habitat or open space. The amount of your income tax deduction will be based on the value of the property before the easement is donated, as compared to and the value after.

 

Family vacation homes can be a wonderful source of enjoyment and memories, but carefully planning to address a complex array of personal and tax issues is essential.