As I write this article, my family and I are on an American Airlines flight en route to Seattle, Washington, where we will begin our weeklong adventure exploring Mt. Rainier and North Cascades National Park. Six years ago, our family embarked on our inaugural outdoor expedition, experiencing the beauty of Yellowstone National Park and Grand Teton National Park in a 56-foot RV. We created such fond memories from that time together that my wife and I committed to continuing these vacations for as long as our five children allow! Over the years, we have seen the majesty of Yosemite Valley, the awe-inspiring ice-capped mountains of Glacier National Park, the rugged coast of California, the crystal-clear bays of St. John National Park, the emerald-green lakes of Banff National Park, and the immensity of the Grand Canyon. We cherish the memories of the amazing places we have seen together!
Of course, I’m not alone in my appreciation of family time spent together on vacations; on our many adventures, we’ve observed thousands of families similarly engaged. For other families, hitting the road together is less appealing. Often, it is a treasured family vacation property that provides the venue for these special gatherings. Perhaps that describes your family. If you own a family property and wish to preserve it for your children or grandchildren, this article aims to guide you through the essential considerations to help ensure a successful transition to future generations.
Assessing Family Interest
Before making any decisions about passing down your vacation home, we advise speaking with your family at an appropriate time to confirm that they share similar feelings about the property. Hopefully, you will discover a mutual appreciation for the property and gain helpful insights to guide future decisions. If you have multiple children, you may learn they hold different opinions about the property. One child may cherish the property and intend to use it as much as possible; another may have less interest in co-ownership for various reasons—perhaps proximity to the property, demanding career, or family responsibilities. In these situations, it is critical to plan thoughtfully to prevent potential conflicts and ensure that those who choose to be involved are fully prepared for the responsibilities.
Navigating Shared Ownership
Shared ownership of a vacation home can be both rewarding and challenging. While it can strengthen family bonds, it can also lead to disagreements and frustration if not handled properly. Establishing clear guidelines regarding the use of and responsibilities associated with the property is essential. As you work with your advisory team—including legal and tax counsel—to develop the optimal shared ownership plan for your property, give thoughtful consideration to the governance topics listed below.
Management Decisions Related to the Property
- Major decisions—costly repairs or renovations, deciding to sell the property, etc.—will likely require either a majority or unanimous agreement of the co-owners. How will the day-to-day management responsibilities associated with the property be handled?
- Will you identify a family member(s) with the authority to make decisions, or will you hire an independent property management company to handle the management of the property?
Policy for Use of the Property
- How do family members go about reserving time to use the property? Will it be first come, first served? An annual meeting where dates are divided up? A shared calendar?
- Does each family member have an allotted number of days each year to use the property?
- Can non-family guests use the property? Does the guest need to be accompanied by a family member?
- Can family members bring pets to the property?
- How should the house be cared for? Who is responsible for cleaning after use?
- Will the property be available for rent if the family is not using it?
Practically speaking, these rules will need to be revisited and modified periodically as the family navigates the dynamics of shared ownership.
Financial Responsibilities
- Do you plan to provide funds for the ongoing financial responsibilities associated with the property, or will your heirs be responsible for these expenses?
- If you intend to provide funds for the property, what amount of liquid portfolio assets will be required? How will these funds be held—in a trust or an LLC?
- If financial responsibility for the property will pass to your heirs, do they have the necessary resources? Will the expenses be shared equally or based on each owner’s use of the property?
Setting an annual budget for property operation and improvements is a good starting point for capital planning.
Future Ownership Changes
- Will you provide the option for a co-owner to exit ownership if they desire?
- If exit is permitted, how will the value of that owner’s interest be determined? What are the terms of payment—lump-sum or installments, interest rate, etc.?
Passing Down the Family Property: Ownership Structure and Transfer Options
If you’re thinking about passing your family property on to future generations, you should consider these questions:
- How will the property be transferred to the next generation in a way that increases the likelihood of a successful outcome for your family over time? Outright? In trust? In a corporate entity?
- When should control of the property be transferred to the next and subsequent generations?
- To whom should the property be transferred? To the entire next generation or only to a select few? If the latter, will you provide compensating gifts/bequests for the others?
Legal Ownership of the Family Property
Commonly, families will establish a trust and/or a limited liability company (LLC) to own the property where the rules governing the shared ownership can be memorialized in the organizational document (Trust Agreement or Operating Agreement).
Irrevocable Trust
Placing the vacation home in an irrevocable trust allows for greater control of property management and decisions regarding the use, management, and sale of the property, but modifications to the trust can be difficult if future changes are warranted.
- The trust agreement can include provisions that define roles and expectations for the next generation.
- Trusts can serve to protect the family property in the event of divorce, family disputes, and actions by creditors.
- Other assets (i.e., liquid investment assets) can be held in the trust to provide funds for ongoing property maintenance and upkeep.
- Irrevocable trusts cannot be easily changed or revised. Depending on the provisions, they may offer less flexibility than other ownership arrangements when it comes to transferring ownership, adding owners, or paying for expenses.
Limited Liability Company
Limited liability companies (LLCs) are a commonly utilized ownership structure for shared family properties. These entities are often used within a trust to separate the real estate from the other assets of the trust or to allow proportionate interests to be held in separate trusts. Holding a family property in an LLC—either within a trust or as an independent entity—allows for greater control over property management and disposition than is possible with an outright transfer of the real estate.
- With the formation of the LLC, the rules governing shared ownership can be memorialized in the operating agreement. In this agreement, you can establish expectations regarding management of the property (how expenses are paid, repairs and maintenance, usage, and third-party rentals, etc.), set forth processes for avoiding and resolving family conflicts, address financial responsibilities of the members, and establish guidelines and parameters for how members can transfer or dispose of their interest. With the approval of the members, the operating agreement can be amended as needed when situations and goals change.
- These entities can hold other assets (i.e., liquid investment portfolio) to provide cash flow to fund the ongoing financial needs associated with the property.
- LLCs provide significant protections against liability claims, creditors, family disputes, divorce, and attempts to force a sale.
- An LLC ownership structure can also facilitate the efficient transfer of ownership within a family. An LLC can be organized with voting and non-voting membership interests, allowing for the transfer of ownership while delaying the transfer of control until appropriate. The value of non-controlling interests in an LLC transferred during lifetime or at death may also be entitled to discounts for lack of marketability and lack of control. A qualified appraisal is required to substantiate these applicable discounts.
Options for Transferring Ownership
Lifetime Gift
Transferring the property during your lifetime allows you to shift the future growth associated with the property outside of your taxable estate; however, your heirs will receive a “carry-over” tax basis in the property. In other words, your heirs will have the same tax basis in the property that you had prior to making the gift. Gifts can be made to your family outright or in trust. Note: For highly appreciated properties, it may be more beneficial from a tax perspective to retain the property during your lifetime and bequeath the property at your death—see paragraph below.
You do not have to transfer all your interest in the property during your lifetime. If the transfer is structured properly, you can retain some use of the property, though it may require paying rent to avoid the risk of estate inclusion. In 2024, you can gift up to $13.61 million or $27.22 million for a married couple without paying current gift taxes. To the extent you use this exemption during your lifetime, it reduces the amount available to gift at your death.
Bequest
Leaving the property in your will or under the terms of your revocable trust allows you to retain full use and control until your death. It also reduces the capital gains taxes that your heirs will incur if they sell the property at some point in the future. Under current law, with some exceptions, assets included in your taxable estate receive a “stepped-up” tax basis equal to the asset’s fair market value at the date of your passing. It is also important to be mindful of estate taxes associated with leaving a property to family members at death. If your estate exceeds your remaining estate tax exemption amount—currently $13.61 million for an individual and $27.22 million for a married couple—you should ensure that you have adequate liquid assets to pay the estate taxes when they are due nine months following the date of death.
Future Interest Gift
A Qualified Personal Residence Trust (QPRT) allows you to transfer the property to your heirs at a future date, reducing the gift’s value and providing you with continued use during the trust term. This strategy is more effective in a high-interest rate environment as the discounted value of the future interest, the gift, is worth less. It is important to know that if you pass away before the trust term ends, the property’s value may be included in your estate. This strategy is not recommended if there is an outstanding mortgage balance on your property.
During the trust term, you can continue to pay the taxes and maintenance expenses associated with the property without creating an additional gift. At the end of the trust term, the property passes to your family. Typically, you are given the option to rent the property from your family beneficiaries following the trust term, which can provide cash flow to cover the ongoing expenses associated with the real estate.
Example
While each client’s situation is unique, it is helpful to learn from what others have done to accomplish their goals. We recently worked with a client who wanted to pass her family homestead to her three children. While all the children currently express interest in maintaining family ownership of the property, our client wisely recognized that their desires may change over time.
The home and adjacent land have appreciated significantly since they were acquired many years ago. With the level of the current estate exemption, estate taxes were not a significant concern. We decided it was best to pass ownership of the property to her heirs via her estate plan to allow for a step-up in cost basis at her death. In collaboration with her attorney, she amended her testamentary estate documents to provide that the property would be held in trust for the benefit of her children. A trusted family member is named as trustee.
This client’s documents also provide that the trust will be funded with sufficient liquid investment assets to maintain the property for five years after her passing. At the end of five years, the trust instrument allows the beneficiaries to “opt-in” to ongoing shared ownership. Any heir uninterested in continued shared ownership will receive other assets distributed by the trustee in lieu of their interest in the property.
The trustee is then instructed to form an LLC with appropriate governance provisions in the operating agreement and to fund it with the property. The LLC interests will then be distributed outright to the trust beneficiaries who “opted-in” to continued ownership. If none of the heirs opted to continue their ownership of the property, the trustee is instructed to sell the homestead and distribute the proceeds to the trust’s beneficiaries.
Our client now feels confident that her wishes will be carried out and that her children are empowered to maintain ownership of the family homestead with the flexibility to change the plan in the future.
Conclusion
A family vacation home can be a treasured asset and a source of joy for future generations. By carefully assessing your family members’ interest and capability, establishing clear guidelines for shared ownership, and choosing the right transfer method, you can help ensure that your vacation home remains a beloved retreat for years to come.
Please reach out to your team at Bragg Financial for guidance on navigating these important decisions.
This information is believed to be accurate at the time of publication but should not be used as specific investment or tax advice as opinions and legislation are subject to change. You should always consult your tax professional or other advisors before acting on the ideas presented here.
Too Much of a Good Thing
July 31, 2024The Best Account of All
August 26, 2024As I write this article, my family and I are on an American Airlines flight en route to Seattle, Washington, where we will begin our weeklong adventure exploring Mt. Rainier and North Cascades National Park. Six years ago, our family embarked on our inaugural outdoor expedition, experiencing the beauty of Yellowstone National Park and Grand Teton National Park in a 56-foot RV. We created such fond memories from that time together that my wife and I committed to continuing these vacations for as long as our five children allow! Over the years, we have seen the majesty of Yosemite Valley, the awe-inspiring ice-capped mountains of Glacier National Park, the rugged coast of California, the crystal-clear bays of St. John National Park, the emerald-green lakes of Banff National Park, and the immensity of the Grand Canyon. We cherish the memories of the amazing places we have seen together!
Of course, I’m not alone in my appreciation of family time spent together on vacations; on our many adventures, we’ve observed thousands of families similarly engaged. For other families, hitting the road together is less appealing. Often, it is a treasured family vacation property that provides the venue for these special gatherings. Perhaps that describes your family. If you own a family property and wish to preserve it for your children or grandchildren, this article aims to guide you through the essential considerations to help ensure a successful transition to future generations.
Assessing Family Interest
Before making any decisions about passing down your vacation home, we advise speaking with your family at an appropriate time to confirm that they share similar feelings about the property. Hopefully, you will discover a mutual appreciation for the property and gain helpful insights to guide future decisions. If you have multiple children, you may learn they hold different opinions about the property. One child may cherish the property and intend to use it as much as possible; another may have less interest in co-ownership for various reasons—perhaps proximity to the property, demanding career, or family responsibilities. In these situations, it is critical to plan thoughtfully to prevent potential conflicts and ensure that those who choose to be involved are fully prepared for the responsibilities.
Navigating Shared Ownership
Shared ownership of a vacation home can be both rewarding and challenging. While it can strengthen family bonds, it can also lead to disagreements and frustration if not handled properly. Establishing clear guidelines regarding the use of and responsibilities associated with the property is essential. As you work with your advisory team—including legal and tax counsel—to develop the optimal shared ownership plan for your property, give thoughtful consideration to the governance topics listed below.
Management Decisions Related to the Property
Policy for Use of the Property
Practically speaking, these rules will need to be revisited and modified periodically as the family navigates the dynamics of shared ownership.
Financial Responsibilities
Setting an annual budget for property operation and improvements is a good starting point for capital planning.
Future Ownership Changes
Passing Down the Family Property: Ownership Structure and Transfer Options
If you’re thinking about passing your family property on to future generations, you should consider these questions:
Legal Ownership of the Family Property
Commonly, families will establish a trust and/or a limited liability company (LLC) to own the property where the rules governing the shared ownership can be memorialized in the organizational document (Trust Agreement or Operating Agreement).
Irrevocable Trust
Placing the vacation home in an irrevocable trust allows for greater control of property management and decisions regarding the use, management, and sale of the property, but modifications to the trust can be difficult if future changes are warranted.
Limited Liability Company
Limited liability companies (LLCs) are a commonly utilized ownership structure for shared family properties. These entities are often used within a trust to separate the real estate from the other assets of the trust or to allow proportionate interests to be held in separate trusts. Holding a family property in an LLC—either within a trust or as an independent entity—allows for greater control over property management and disposition than is possible with an outright transfer of the real estate.
Options for Transferring Ownership
Lifetime Gift
Transferring the property during your lifetime allows you to shift the future growth associated with the property outside of your taxable estate; however, your heirs will receive a “carry-over” tax basis in the property. In other words, your heirs will have the same tax basis in the property that you had prior to making the gift. Gifts can be made to your family outright or in trust. Note: For highly appreciated properties, it may be more beneficial from a tax perspective to retain the property during your lifetime and bequeath the property at your death—see paragraph below.
You do not have to transfer all your interest in the property during your lifetime. If the transfer is structured properly, you can retain some use of the property, though it may require paying rent to avoid the risk of estate inclusion. In 2024, you can gift up to $13.61 million or $27.22 million for a married couple without paying current gift taxes. To the extent you use this exemption during your lifetime, it reduces the amount available to gift at your death.
Bequest
Leaving the property in your will or under the terms of your revocable trust allows you to retain full use and control until your death. It also reduces the capital gains taxes that your heirs will incur if they sell the property at some point in the future. Under current law, with some exceptions, assets included in your taxable estate receive a “stepped-up” tax basis equal to the asset’s fair market value at the date of your passing. It is also important to be mindful of estate taxes associated with leaving a property to family members at death. If your estate exceeds your remaining estate tax exemption amount—currently $13.61 million for an individual and $27.22 million for a married couple—you should ensure that you have adequate liquid assets to pay the estate taxes when they are due nine months following the date of death.
Future Interest Gift
A Qualified Personal Residence Trust (QPRT) allows you to transfer the property to your heirs at a future date, reducing the gift’s value and providing you with continued use during the trust term. This strategy is more effective in a high-interest rate environment as the discounted value of the future interest, the gift, is worth less. It is important to know that if you pass away before the trust term ends, the property’s value may be included in your estate. This strategy is not recommended if there is an outstanding mortgage balance on your property.
During the trust term, you can continue to pay the taxes and maintenance expenses associated with the property without creating an additional gift. At the end of the trust term, the property passes to your family. Typically, you are given the option to rent the property from your family beneficiaries following the trust term, which can provide cash flow to cover the ongoing expenses associated with the real estate.
Example
While each client’s situation is unique, it is helpful to learn from what others have done to accomplish their goals. We recently worked with a client who wanted to pass her family homestead to her three children. While all the children currently express interest in maintaining family ownership of the property, our client wisely recognized that their desires may change over time.
The home and adjacent land have appreciated significantly since they were acquired many years ago. With the level of the current estate exemption, estate taxes were not a significant concern. We decided it was best to pass ownership of the property to her heirs via her estate plan to allow for a step-up in cost basis at her death. In collaboration with her attorney, she amended her testamentary estate documents to provide that the property would be held in trust for the benefit of her children. A trusted family member is named as trustee.
This client’s documents also provide that the trust will be funded with sufficient liquid investment assets to maintain the property for five years after her passing. At the end of five years, the trust instrument allows the beneficiaries to “opt-in” to ongoing shared ownership. Any heir uninterested in continued shared ownership will receive other assets distributed by the trustee in lieu of their interest in the property.
The trustee is then instructed to form an LLC with appropriate governance provisions in the operating agreement and to fund it with the property. The LLC interests will then be distributed outright to the trust beneficiaries who “opted-in” to continued ownership. If none of the heirs opted to continue their ownership of the property, the trustee is instructed to sell the homestead and distribute the proceeds to the trust’s beneficiaries.
Our client now feels confident that her wishes will be carried out and that her children are empowered to maintain ownership of the family homestead with the flexibility to change the plan in the future.
Conclusion
A family vacation home can be a treasured asset and a source of joy for future generations. By carefully assessing your family members’ interest and capability, establishing clear guidelines for shared ownership, and choosing the right transfer method, you can help ensure that your vacation home remains a beloved retreat for years to come.
Please reach out to your team at Bragg Financial for guidance on navigating these important decisions.
This information is believed to be accurate at the time of publication but should not be used as specific investment or tax advice as opinions and legislation are subject to change. You should always consult your tax professional or other advisors before acting on the ideas presented here.
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