How to Help Clients Plan for Vacation Home Succession
The weather is still great. The grill is still out. Your client hasn’t put away the yard furniture yet and is still enjoying another summer of barbecues, late nights on the porch and watching their family play games in the yard. While living in that bliss, it’s easy for clients to assume that the house will be there forever, that everyone loves it as much as they do and that it will be passed down to their children seamlessly. Unfortunately, that assumption is exactly what causes problems.
A vacation home becomes one of the hardest assets to hand down cleanly and requires careful planning, because the value of a vacation home isn’t just financial; it’s emotional. Your clients need to avoid the common pitfall of assuming all of their children want the vacation home and can afford to maintain it.
Thankfully, while still enjoying the house and making decisions, your clients are well-positioned to solve these problems before they arise.
A Frank Discussion
The first step is always for your clients to have a frank discussion with their children about what they want and what they can realistically afford. Clients may be surprised at the results. Realistically, it’s hard for anyone to predict what their situation will be decades from now after you’re gone. While a child may love using the vacation home now, they could be living across the country in 20 years and have little interest in such a vacation spot. How would a child feel if they were forced to co-own and pay for a home that they never used or, even worse, couldn’t afford? This is a minefield for sibling squabbles and discontent. Additionally, the financial circumstances of your client’s children can and will change over the years. For these reasons, giving the children an “option to purchase” the vacation home at the second spouse’s death is a great choice. This way, the children can actively make a decision that’s suitable for their life circumstances at the time of your client’s passing, and your client doesn’t need to make the decision for them before they’re ready. You can structure the option so that the children can use part of their inheritance toward the purchase price, ensuring that each child gets what they want and that there are no hard feelings between the siblings.
LLCs
If and when your client and their children are sure that they can commit to being co-owners of a vacation home, a limited liability company is a great way to have centralized management, outline when and how additional funds should be added to the LLC to cover carrying costs and arguably most importantly, restrict the transfer of interests in the LLC to third parties. From there, the manager of the LLC and the members can establish operating procedures outlining when each member is permitted to use the home and other important property management issues. Preparing the client’s family with an LLC is a helpful foundation for real estate co-ownership, but it’s important to be mindful that even with the best planning, family dynamics can change over time, so the LLC should also provide a way to unwind the arrangement fairly. Don’t force a co-ownership arrangement that isn’t wanted or isn’t working. Whether the property is a cabin in the woods or a beach house worth millions, the planning works the same way.
Gift During Life or at Death?
As part of the planning process, your client will need to decide whether to make a gift of the vacation home during their lifetime or hold it until their death. The benefit of holding onto the home until the client’s death is twofold: (1) If your client continues to use the home, they won’t need to pay rent for the pleasure of using it; and (2) Your client will receive a step-up on the basis of the home at death, which can mitigate capital gains tax consequences for the client’s children. If your client gives the home away during their life, the reverse is true. They either have to stop using the home or pay rent for using it, and the recipient receives their carryover basis (and if they plan on selling eventually, that will increase their capital gains taxes). The upside of giving the home away during life is that it may reduce your state estate tax consequences.
If your client owns a vacation home individually, and they want to make sure that their spouse has the right to use the home after their death before passing the home to their children, then it’s imperative to make sure their interest in the home is held in a trust for the spouse’s benefit. This gets even more complex with blended families. What I see most often isn’t bad planning, but no planning. Your client’s trust should outline exactly the rights and authorities the spouse will have in connection with the vacation home. Will they pay rent? Who’s responsible for operating expenses such as utilities, landscaping, real estate taxes and mortgage payments? What about capital expenses like a new roof or siding? By establishing a trust with a clear, impartial trustee, your client can protect both their surviving spouse’s ability to use the home and their children’s eventual claim to it.
A Fair Plan
Finally, it’s crucial to make sure your client considers what’s already happened. If a child has spent years quietly covering the home’s maintenance, that history should count, and a fair plan will let them recoup it. But the biggest lesson I’ve learned in my years dealing with families and estate planning is that the families who avoid ugly conflicts are the ones who discussed the important issues while everyone was still around the table. Open communication to find out what their family truly wants is essential. Waiting until it’s too late just opens the door for misunderstandings, hurt feelings and potential legal battles.
