Family Vacation Homes

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. Here’s a
few:

Revocable Trust –
This won’t affect a current transfer of the property, but 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 have a deed  prepared reflecting 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 1/10^th of the condo.

General Partnership
(GP) or Limited Liability Company (LLC) – If gifts will be made over a
longer duration, which could cause the deeds will become too cumbersome, of if local
transfer taxes or fees are costly, or if there are minor children (who cannot
own real estate directly under state law), you might have a simple GP or LLC
own the property, which allow 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. 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 could 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 doesn’t 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’re 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’re 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’re 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 buy out 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.