Summer is finally here, and you may have plans to spend time at your vacation home with family and friends. If you own a vacation home or are considering purchasing one, it is wise to create a plan for keeping the home in the family at your death or selling it if associated costs become unaffordable. There are a number of options for keeping vacation homes in the family such as gifting a vacation home or putting a vacation home in a Trust or an entity. Below is a short list with the upsides and downsides.
Wills. Individuals can distribute property they own in their individual names to the people whom they choose upon their deaths via their Wills. However, assets transferred under a Will must go through the public probate court process, which can be time-consuming and expensive. Probate avoidance is a great gift you can give to your family.
Gifting. Individuals can make gifts of vacation homes during their lifetimes. The property would avoid probate and be removed from the individual’s taxable estate, thereby avoiding estate tax on the property. Many people consider gifting a house to avoid paying estate tax. However, on the downside, the donor gives up control of the asset, and the asset is subject to the reach of the creditors of the donees who receive the property. Also, the donee’s tax basis in the property would be “carryover basis”. Tax basis is used to calculate the tax payable upon the sale of property. Individuals who receive gifts of property have a basis in the property that equals the price the donor paid for the property. If an individual inherits property at a person’s death, the basis in the property will “step up” to the value of the property at the time of death.
An important consequence of gifts made during life and after death is the basis of property. If a parent purchases property for $500,000 and transfers it to children during life, then the children will have the same basis as the parent ($500,000). If the children sell the property for $1 million, the children will pay tax on gain in the amount of $500,000 (the difference between the $1 million sale price and the $500,000 tax basis).
However, if the parent dies owning property worth $1 million and leaves the property to his or her children, the children will have a stepped-up basis in the property of $1 million. If the children sell the property upon the parent’s death, no gain will result. The children will not pay income tax upon selling the property. However, the property will be includable in the parent’s estate and subject to the estate tax. The Massachusetts estate tax rate ranges from 4.6% to 16%. Combined federal and Massachusetts capital gains rate can be 20% to 25%. Thus, opting until death to pass property to children may be favorable for tax reasons.
Trusts. Assets titled in trusts during a person’s lifetime avoid probate. This is one of the reasons for placing property in a trust. A person who creates a revocable living trust is the grantor. Upon transferring title of an asset to a revocable trust, the grantor retains control of the asset and usually serves as Trustee of the trust and is the sole beneficiary of the trust during his or her lifetime. The grantor can name a Trustee to manage assets in the trust for the remainder beneficiaries (i.e. those who will be the beneficiaries at the grantor’s death). Trusts can be structured to provide creditor protection for property held in trust against a beneficiary’s creditors such as a divorcing spouse, tax liens and bankruptcy. Property in this type of trust will get a step-up in basis at the death of the grantor.
Entities. A limited liability company (LLC) or a family limited partnership (FLP) can own a home and transfer the ownership of a home to future generations. An LLC or FLP can provide rules for a home’s use and operation, limit ownership of the underlying property to family members and provide buyout terms so that an individual family member cannot force a sale of the property. Payment of repairs, insurance and taxes can be outlined with family members paying into an account for cleaning and maintenance annually or paying costs for the time that they use the vacation home.
A vacation home is a great gift, and passing it on to your loved ones is a wonderful way to continue family traditions and promote family bonding. It is important to consider all of your estate planning options in relation to a vacation home. Make sure you have a plan in place to ensure your vacation home continues to be a blessing and does not become a curse.
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