Summer is on its way. If you’re fortunate enough to own a vacation home, you’re likely making plans to gather with your loved ones for another season of fun and relaxation. Whether your special place is in the mountains, by the beach or on a lake, this is where your family gathers to make new memories and share family traditions.
How do you balance family memories with future plans?
For sentimental reasons, many people want to keep their second house in the family for future generations. However, a family vacation home can quickly become a source of conflict down the road unless you have a clear plan for transitioning the property to your heirs.
Here are three tips to help minimize family friction when deciding how and when to transition a vacation home.
- 1.Trust but verify. Your most fervent hope may be for your family to gather at the summer house for the annual July 4th barbeque. However, unless you confirm that your children share the same wish, you could be setting them up for discord down the road. Consider holding a family meeting to discuss how each of your children feels about your vacation home. You may find that all of your kids are gung-ho about preserving this tradition for generations to come. Conversely, you could also learn that one or more of them sees the house as a source of cash and wants to sell it. Knowing their true feelings will make it easier to decide what to do with your vacation home now or after you’re gone.
- 2. Consider your options. Proper planning in advance can be the key to ensuring a smooth transfer of the property. If your vacation home is owned outright, a simple transfer to the next generation by will or deed may seem easiest. However, there are potential risks to consider. For example, gifts during life are subject to gift taxes, and transfers at death may be subject to estate taxes. Simply naming one child as joint owner can frustrate goals to treat all children equally. Further, leaving your vacation home to your children (by will or deed) as “tenants in common” can create issues, because under property laws each owner has the right to:
- Force the sale of the vacation home if he or she wants to cash out and the joint owners don’t step in to buy out his or her interests.
- Renovate the property, mortgage or transfer his/her interest in the property, or rent the property to a third party at any time.
- Use the vacation home at will, even if the co-owners don’t have equal interests in the property. For example, let’s say Jane holds a 50 percent interest in her family vacation home, and her two brothers, John and Steven, each inherit a 25 percent interest. Under real property law, Jane’s majority interest doesn’t entitle her to exclusive use of the home 50 percent of the time—she and her brothers have equal access to the home. Yet Jane is nonetheless responsible for 50 percent of the maintenance expenses.
One way to avoid the pitfalls of a tenancy-in-common structure is by transferring the ownership of the vacation home to a trust or limited liability company (LLC). Interests in the trust or LLC can then be transferred to your children, immediately, over a period of time, or at death. Periodic gifts over time may enable you to take advantage of the annual gift tax exclusion amount ($28,000 for a married couple filing jointly in 2014) to minimize transfer tax consequences.
A trust or an LLC agreement offers other important benefits, including the ability to:
- Prevent a forced sale of the property in the event a joint owner wants to cash out by establishing buyout terms for the other owners who wish to keep the property.
- Protect the ownership interest of a family member by addressing how the interest is treated in the event of death or divorce. This can help ensure your vacation home remains in the family by preventing a non-family member from acquiring an ownership interest.
- Create an endowment fund for expenses, thus addressing any potential conflicts that may arise when one or more owners cannot afford their share of the cost of property maintenance.
- Establish rules for scheduling, expense sharing, dispute resolution and agreement modification, thus helping to avoid court involvement.
- Limit the owners’ exposure to lawsuits by vacation home users and creditors.
- 3. Set expectations. Transferring property is relatively easy; maintaining harmony among the owners can be a challenge. The best way to do this is to engage your children (the next generation of owners) in writing down basic guidelines for how the house should be used and operated not just today, but in the future, too. This document should also set rules about maintenance, repairs and operating costs, including who will oversee them and how they will be paid for. It should also specify what an owner can and can’t do without the consent of the other owners (e.g., renovate the house, mortgage or transfer his or her interest in the property, or rent the property to third parties). And it should provide a list of rules for the scheduling and use of the vacation home. This process not only creates “buy in” from family members, it also provides a great opportunity for all of you to honor the traditions your vacation home represents.
The vacation home where you and your loved ones have spent happy times together holds wonderful memories. Now may be the perfect time to discuss your desires for this special place with your estate planning attorney or wealth management advisor. With forethought and careful documentation, you may be able to transition that property to the next generation while helping to preserve your close family relationship.