How you pass on your family vacation home can greatly influence if it remains a special, positive place for future generations. The following are some important considerations to discuss with your advisors.

Summers at the beach with children and grandchildren playing in the water, clam bakes in the backyard, the smell of sunscreen, and sticky ocean breezes. Vacation homes are often special gathering places where family memories are made, leading many to want to keep them in the family.

 How you pass on a home to your heirs can greatly influence whether it continues to create a positive bonding environment for future generations or becomes a financial burden or worse, a hotbed of sibling and other intra-family acrimony.

If you are thinking about passing on your vacation home[1], it is important to first speak with your heirs to determine if they want the home, how much they might use it, and if they have the resources to maintain it. If you have more than one child, you may find that each has a different level of interest and ability to use or maintain the home. Factors including distance from the home, schedules, lifestyles, wealth levels, and other commitments will affect how much they might use the property and whether they want to, or can, take on the responsibilities of ownership.

*Planning Point: When one or more of your children say they want to own the property after you are gone and others do not: Consider including language in your estate documents, such as your will, allowing your children the right to opt-in when it comes to receiving the vacation home as part of their inheritance. Those opting not to receive their share of the property can receive other assets of equal value. It’s important that your children understand that opting in will make them responsible for future expenses; likewise, opting out will make future use and enjoyment of the property unlikely.

The Balancing Act

It is not uncommon for one member of the family to use the family vacation home more than others. This can become a source of contention among family members even when this is due to factors such as where they live in relation to the property or personal choice.

Balancing the responsibilities and benefits of ownership with multiple family members can be difficult. Having the children engage in an open dialogue about their expectations and setting clear guidelines for use of the home can help prevent misunderstandings and miscommunications that can lead to family discord. Arrangements can be informal verbal agreements or more formal written documents outlining use schedules and expense responsibilities.

Use of the property does not necessarily have to be equal, but everyone should feel that they are getting some benefit based on their expectations and circumstances.

Example: Balancing the Benefits

John and his two sisters, Angela and Susan, are each one-third owners of a beach home in Florida that they received from their mother’s estate. John has a stable career, but has limited disposable money. He lives nearby with his wife and three children and expects to often spend time at the property. Angela is a successful patent attorney and lives in Atlanta. She is unmarried and has no children. She also enjoys spending time at the beach home although she expects to spend less time there than John due to its distance from her home. Susan is an executive with a large manufacturing firm and lives in Oregon with her family, including three children. Susan has a busy schedule that prevents her from using the property for more than a week or two each year.

To adjust for this inequality of use, the siblings cover the maintenance costs in proportion to their usage and wear and tear on the home. John and Angela share the property taxes with Angela covering a larger proportion. John looks in on the property regularly, coordinates the payment of bills, and hires repairmen as necessary. The use of the property is scheduled ahead of time, and Susan is given priority on dates of usage when they can be accommodated.

Avoiding the White Elephant

Property taxes, maintenance, unexpected repairs, debt service (if applicable)—it all adds up. We believe that part of any plan to keep a vacation home in the family should address how to cover its ongoing costs.

Know how your children plan to meet these expenses after they become owners. If your children are uncomfortable with having these discussions in a group setting, it may be best to speak with them individually. If they will need additional assets from you to meet these expenses, you should take that into account in your gifting or estate planning. If it becomes clear that your children will not have sufficient assets to maintain the property without significant assets from you, you may want to reconsider your plans to transfer the property to them.

*Planning Point: If you will be passing additional assets to support the property, consider placing these assets in trust. This allows the assets to be used for ongoing property expenses and not for other purposes. It may be beneficial to have the property itself held in trust as well. Placing these assets in trust can provide additional benefits, such as protection against creditors and easier administration for covering costs of the home.

*Planning Point: Under current law, the ability to deduct property taxes, combined with other state and local taxes, is limited to $10,000 per year.[2] Depending on your current tax situation, the additional property taxes on the vacation home may not provide an income tax benefit. Holding the property in a taxable trust (one that pays its own income tax) may enable the trust to utilize this income tax deduction. Note: Placing assets in trust should be done in light of your overall planning goals. In our opinion, assets should not be placed in trust solely to obtain a property tax deduction.

To Keep or Not to Keep

Before you decide to transfer the family vacation home to the next generation, we believe it is important to find out the following:

  • Are your heirs interested in owning the property?
  • How much do each of your heirs’ families think they will use the property?
  • Do your heirs have the resources to cover the financial commitment of ownership?
  • Do your heirs have a good relationship with each other?
  • Do you feel your heirs can work through any issues that occur, for instance, arising from differing amounts of use or ability to cover costs?

Prepping for Shared Ownership

If the property is not already owned in an entity, such as a limited liability company (LLC) or family limited partnership (FLP), you may want to consider transferring it to such an entity. These entity structures can serve as a convenient way to pay bills and hold assets for future expenses, as well as formally outline rights and responsibilities for each owner. These types of structures can also protect the family’s other assets from liability exposure. For example, if someone is injured on the property and decides to sue, having the property owned by an entity can protect your other assets, including your primary residence and investment portfolio, if the case is decided against you. An additional benefit of owning the property inside an entity is the ease of transferring partial interests in the entity when compared to transferring partial interests in the property itself. Owning the property inside an entity does add an additional layer of administration, including setting up the entity and ongoing reporting responsibilities, including tax returns. Also, some states impose a real property transfer tax when transferring real property from individual ownership to an entity such as an LLC.

*Planning Point: If your vacation home is in a state other than where your primary residence is located and it is owned in your name, your estate may need to go through ancillary probate in the state where your vacation home is located. This can be a time-consuming administrative burden. Placing the property in an entity, such as an LLC or limited partnership, or in trust would eliminate the need for ancillary probate.

Timing is Everything

There are three primary ways for you to pass your vacation home on to your heirs: during your lifetime as a gift; after your death as part of your estate plan; or as a future interest gift. While it is common to consider making gifts during your lifetime or after your death, the future interest gift combines some of the benefits of both of these strategies.

The future interest gift works particularly well for gifting real property, including your vacation home. A future interest gift will allow you to have unlimited use of the property for some time, lower the amount of gift tax exclusion a transfer would use, and help ease concerns about your family members’ ability to cover initial ownership costs. Future interest gifts can be accomplished through a Qualified Personal Residence Trust (QPRT). This type of trust allows you to transfer the property at a future date at a lower gift value than if you gifted it immediately. You will continue to pay all property expenses and can have unlimited use of the property during the trust term, which is set by you when the trust is established. At the end of the trust term, the property passes to your heirs. You may not use the property after the trust terminates unless you pay market rent.[3] Some find that paying rent is an effective way to provide assets for future property expenses although it may have income tax implications for the children. It is important to note that if you die before the QPRT term expires, the value of the property is included in your estate as if you had not transferred the property to the QPRT.

Your main concerns and objectives will influence which transfer method may be best for you and your family. Below are some issues and goals for you to consider:

Providing Advice and Guidance

If you feel that your family could benefit from your advice and guidance during the ownership transition process, you may want to consider with your legal and tax advisors transferring the property sooner rather than later. Transferring during your lifetime, either by gift or through a future interest gift, can enable you to participate in the transition process. You can lend a guiding hand as the children hammer out the shared ownership arrangement and be the voice of experience when it comes to maintenance and upkeep needs. This can help your heirs have the best chance to succeed as owners.

Transferring Your Vacation Home

Method Benefits Burdens
Lifetime Gift (An outright gift)
  • Future appreciation is removed from your taxable estate 
  • You are still available for advice and guidance during the transition process
  • Possible gift tax implications
  • Your use of the property will no longer be unlimited
  • Possible higher capital gains tax exposure for your children if they sell the home 
Bequest (After Your Death)
  • Capital gains tax exposure may be significantly reduced due to step-up in basis
  • You can adjust for changes in family circumstances that occur before your death
  • You retain the legal right to unlimited use of the property until your death
  • Possible estate tax implications
  • Ancillary probate if property is located in another state
  • Administering the estate may be time consuming and costly
Future Interest Gift (Using a QPRT)
  • You retain legal right to unlimited use of property before expiration of the trust
  • Can provide a means to transfer additional resources through your payment of rent after expiration of trust
  • Includible in your taxable estate if you die before expiration of trust
  • Adjustment for future changes in family circumstances may not be possible

Tax Minimization

If the property has appreciated substantially or you expect it to appreciate substantially during your lifetime and you anticipate your heirs might decide to sell it at some point, you may want to consider passing the property after your death. While gift taxes and estate taxes are no longer a concern for most families[4], the method of transfer you choose can affect the capital gains taxes for your heirs if they sell the property. Generally, assets passing through an estate will receive a basis step-up at death while assets passing during your lifetime will not. The basis step-up eliminates any unrealized capital gains in the property.

Finding Flexibility

Families change, and their needs and desires can change as well. If there are uncertainties regarding the prudence of transferring the property, you may want to include the property in your estate plan. This can provide you and your heirs the gift of time: Time for you to adjust your estate plans based on changed needs, and if necessary, time for your heirs to prepare themselves, financially or otherwise.

Selling the Property

After weighing your options, you may decide that transferring the property to your children may not be the best idea. If you want to continue to use the property for the rest of your life, you can direct that the property be sold by the executor of your estate after your death.

Selling your vacation home while you are alive can have significant income tax implications depending on the amount of unrealized capital gain. However, you may be able to eliminate some or all of the gain if you make your vacation home your primary residence prior to its sale.

*Planning Point: The Internal Revenue Code allows couples who file jointly to exclude up to $500,000 of capital gains ($250,000 for single filers or married persons filing separately) from the sale of a primary residence.[5] To qualify for this exclusion, you must have owned the residence and used it as your primary residence for at least two of the last five years. While many vacation homes will not meet this primary use test, you may want to consider making your vacation home your primary residence for two years before selling it, as the potential savings could be significant.

Make A Plan; Revise as Necessary

Owning a vacation home can be a great thing for a family. However, what’s good for you may not be as good for others. Understanding your children’s desire and ability to own the property after you are gone can guide the decisions you make today and in the future. These decisions can help preserve the special place the home has within the family and build a foundation for additional memories to come.

For more information, please contact your PNC Private Bank advisor.