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Keeping It in the Family: Planning for the Vacation Home

As with all things money and family, it can be a struggle to balance financial and personal goals with avoiding hard feelings and disputes.

Many reconnect with their family during their vacations. Your client's family may own a home on the beach, in the mountains or in the country where multiple generations gather each year. The home may have been in your client's family for generations, or it may be newly purchased. Regardless, the family vacation home is a unique asset that symbolizes important memories and family connections. For this reason, clients should specifically address the vacation homes in their estate plans to avoid hard feelings and even disputes.

To begin, define your client's goals for the vacation home as it passes to successive generations. These goals should be evaluated in the context of applicable tax laws to determine the impact, if any, that the potential transfer has on any tax benefits. Clients should understand the available planning strategies and how these strategies will further their goals. Lastly, they should begin to address the ongoing issues often encountered with ownership of a vacation home used by different family lines. With proactive planning, a family can avoid many of the pitfalls that happen as a treasured asset moves from one generation to the next.

Options to Consider for the Vacation Home

Your client may not be ready to transfer the family vacation home to the next generation as they are still enjoying it, or they may feel their children are not ready to manage the property. Even if your clients are not ready to transfer the vacation home, they should still plan for how it will pass when they die.

Some distribute the vacation home at their death with their other assets, giving their children an equal interest in the home. Each child’s interest will have certain rights associated with it, including the rights to use and partition the property. The division of expenses, labor and benefits could be unclear and hard to enforce. A child could transfer the interest in the home to individuals outside the family.

Because of this risk, your client may wish to proactively create a structure to own and care for the home following their death. They may wish to address expense allocation, restrictions on transfers and encumbrances, and removal of the right to partition. They may also seek to protect against potential liability that could arise related to the home.

Your client could leave the home in a trust specifically designed to own this type of property—often called the Vacation Home Trust. In this type of trust, you designate who has the right to use and enjoy the home. You establish the rules for such use and consequences for failing to follow those rules. You also should set who will manage the home itself. The Vacation Home Trust should own other assets to fund the home’s upkeep and maintenance. Lastly, this type of trust can be designed to last in perpetuity.

Alternatively, you could create a closely held business entity (such as a family limited partnership or limited liability company) to own the home. Once the home is transferred to the entity, it is no longer owned by the individuals themselves, providing a level of creditor protection. This structure is popular when third parties, such as renters, use the home regularly. Many also implement this structure to provide continuity, consolidate management and proactively implement succession planning among the generations.

Taxes that Impact the Succession Plan for the Vacation Home

In addition to personal planning goals, planning for taxes should be considered. These taxes include federal gift, estate and generation-skipping transfer taxes, state estate taxes, income and capital gain taxes, and state and local property taxes.

If you anticipate the home will appreciate in upcoming years, it may be an ideal asset to transfer during life. Several advanced planning options are available, including a gift to an irrevocable trust, an installment sale to a defective grantor trust and a gift to a qualified personal residence trust, which can benefit both your client and future generations. Each of these techniques allows your client to address the interpersonal and practical use issues that commonly accompany a vacation home while carrying out the overall objectives of implementing tax savings.

Planning to Avoid Discord

In addition to preserving the home for future generations and tax efficiency, many families have other objectives that can be achieved through proper planning. Transferring a vacation home to future generations typically involves multiple family lines co-owning a single asset. Disagreements will arise.

Frequently, these surround two common themes—the allocation of expenses to maintain the home and the right to use the property. By prospectively addressing these issues, a family can avoid not just hard feelings and disagreements, but also possibly litigation.

The important issues to address include arranging for the payment of expenses related to the property (ongoing, ordinary costs and property improvements) and establishing each family member’s rights to use the property, as well as the rules related to that use. Many wish to protect the family from liability arising from the use of the home and protect the home from liability related to family members personally. Your clients can address the ability of non-family members to use the property, including whether the home should be rented and delegate responsibility for managing the property. Lastly, they may decide to limit the family’s ability to sell the home and the conditions upon which a sale, if any, is acceptable.

To achieve these goals and preserve the family vacation home for future generations, your client's estate plan should implement a structure specifically designed to ensure the transition is consistent with their personal and tax-planning goals.

Jennifer Davis and Elizabeth Pack are both officers at Greensfelder, Hemker & Gale PC. 

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