In some cases, the home may pass by will to children and other heirs, incurring burdensome estate taxes. In other situations, it may become a source of conflict or become part of a forced sale to settle debts or taxes, and in some cases it may pass uneventfully tax-free to the intended heirs. When transferring a vacation home to your heirs, one thing is clear: You need to plan ahead.
According to the U.S. Census Bureau, between 2000 and 2010 the number of vacation homes grew by more than 27 percent. Most were located in Florida, Michigan, New York, and California, but family cabins and cottages are located throughout the United States. Whether built for fishing, hunting, skiing, or a break from the cold weather, vacation homes tend to become part of the family memory book.
However, issues such as maintenance, upkeep, taxes, and frequency of use could result in constant disagreements and eventually the loss of the home. Rather than hope the children “can work it out,” the initial owner can implement a plan for future generations.
The process begins by answering three critical questions:
- Do my descendants want the vacation home or would they prefer to inherit other assets? Before making decisions regarding the future of your vacation home, it is important to sit down with all intended beneficiaries and determine whether they want to inherit that particular asset. Some family members may want continued use of the home, while others may prefer to inherit a different asset. For example, the home may be located a long distance from the primary residence of an heir, creating a burdensome travel expense, or some family members may be more able to afford to maintain the home than others. In addition, some heirs may be more responsible than others and likely invest in maintenance and repairs. Others may simply want the benefit of using the home without any financial responsibility. Before transferring ownership of the vacation home, decisions need to be made about who will have use of the home, who will pay the property taxes and other expenses, when and for how long each heir be permitted to use the home each year, and how other decisions regarding the property will be made. It is important to not only develop a plan for use of the vacation home, but to put that plan in writing and make each heir sign off on it.
- If my descendants want use of the vacation home, what would be the most tax-efficient way to transfer ownership or control? From a tax perspective, the top three options for bequeathing a vacation home to heirs include as a gift or as a qualified personal residence trust, or by placing it in a family limited liability company. Gifting shares of the property over a period of time and within the federal gift exclusion avoids taxation. Currently, under federal tax law, estate holders are permitted to give away up to $14,000 a year per person tax-free and married couples may gift up to $28,000 tax free. If the value of each share exceeds the annual exclusion, a percentage of each share can be granted over a period of years to avoid taxation. In the alternative, a vacation home may be transferred to a qualified personal residence trust (QPRT). When the home is transferred to a QRPT, the owner retains the right to live in the home for a set period of time and during that time, remains responsible for all expenses, such as property taxes and repairs. Once that time period expires, the house is transferred to heirs with no estate tax liability. Finally, ownership of the home could be placed in a limited liability company or LLC. The shares of the LLC are distributed to family members. Shareholders are responsible for creating an operating agreement that stipulates conditions about access, payment of taxes, maintenance and repairs, and other expenses. The creation of an LLC permits the owner to retain control over the vacation home even after shares are distributed to the heirs.
- Is there a possibility I will require long-term care in the near future? In California, the transfer of major assets to heirs, such as a vacation home, must take place more than 30 months before seeking Medi-Cal assistance for long term care. Medi-Cal is a needs-based program and there is a limit on the value of assets a resident can have to qualify for the program. Excluded from the needs calculation are the primary residence, one vehicle, household goods and personal belongings, and jewelry. A second or vacation home is not excluded. Therefore, it is best to make arrangements concerning a vacation home before nursing home admission becomes a possibility. If the transfer is seen as a way to avoid income limits, eligibility for Medi-Cal may be delayed. That means it may become necessary to sell the vacation home to pay for a portion of long-term care costs.
With property ownership comes certain responsibilities, including proper maintenance and payment of taxes and fees. If potential beneficiaries are unwilling or incapable of meeting those responsibilities, several options may be available. For example, the estate holder could provide funding for maintenance and repairs, or require each heir to contribute to a maintenance fund annually as a condition of continued use of the property. The payment of property taxes could be pegged to use, or the responsibility divided equally among all heirs with penalties imposed for failure to pay or late payment.
Similarly, it is important to create rules about use of the property. For example, if one heir causes significant damage to the home, or permits a non-family member to use the property without the knowledge of others, how will those issues be addressed? It might also be wise to create an inventory of the property to ensure fixtures or furniture are not removed without the permission of all beneficiaries. Similarly, rules regarding the grounds, such as the maintenance of gardens, or the installation of permanent fixtures, such as a gazebo or deck, should be in place.
Everyone likes to think their immediate family will do right by other heirs. But there is no way to anticipate the actions of others, especially descendants further down the family line, such as grandchildren or great grandchildren. That is why it is important to put a lasting plan in place for the family vacation home.