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How to pass down your vacation home

Key takeaways

  • Many parents wish to keep vacation properties in the family, but it's important to establish up front which, if any, heirs are interested in ownership.
  • There are many options for gifting a property, including joint ownership, a bequest through a will, and several types of trusts.
  • A financial professional or attorney can help you select the correct way to transfer the home and assess the estate tax implications, if any.

For many families, a vacation home is far more than a piece of real estate. It's a gathering place where traditions are strengthened and treasured memories are made—and one that many parents would like to pass on to the next generation.

But passing on property can be more complicated than gifting financial assets. A vacation home comes with an assortment of ongoing costs, from taxes to upkeep. Especially if the property is in an attractive vacation destination, it may make up a significant portion of the older generation's estate, but unlike money in a bank account, it can't be easily divided. "When expectations aren't clearly established up front, I have seen situations where an inherited vacation home leads to family disputes," says Michael Christy, regional vice president of advanced planning at Fidelity.

Given the complexities, the appropriate approach to passing down a house often isn't clear-cut. There are many options to consider, including conjointly owning the property with your child, selling it to an interested heir, making a bequest via a will, or putting the house into a trust. As with most planning strategies, there are pros and cons to consider before settling on the option that is right for you and your family. A financial professional can help you talk through the decision, as well as assess the potential implications to you and your heirs' taxes and estate plans.

Here are 4 key questions you'll need to consider.

1. Are your heirs really interested in owning the property?

If your family has spent years or even decades gathering at a beloved spot, it's natural to assume that your kids will want to carry on the tradition. That may not be the case, cautions Christy. Start by having a nonjudgmental conversation where you simply ask for their thoughts. "It's important to ask your heirs what they want before you tell them what you want," Christy says. "Don't project your desire onto them and make them feel like they can't say no." And be open to the possibility that your kids may prefer to inherit cash instead. "If that's the case, don't be afraid to sell the home and provide the proceeds," says Christy.

If you have more than one child interested in ownership, it's worth thinking through how you and they might resolve some potentially challenging situations. Would your kids be able to divide time at the property equitably without conflicts? How would it work if one eventually wanted to buy out the other's interest in the property? If equality is important to you and not all siblings inherit the property, you'll likely need to adjust your estate plan to achieve equal bequests for other beneficiaries.

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2. Who would pay for ongoing maintenance?

Another important area to think through: Current and potential expenses related to the property. While all houses will require paying for insurance, property taxes, and some amount of regular maintenance, older homes can be especially costly. Another factor is the condition of the property. A family home in a destination location, such as a beach house, may be an attractive inheritance, even if it requires substantial repairs. In these situations, however, the intended beneficiaries may prefer to not inherit the home, but rather receive the proceeds of the home's sale.

If your heirs would be sharing the property, you may want to consider outlining in writing how ongoing costs would be divided. That's especially important if one sibling would be using the property more than others or might wind up taking on a greater share of caretaker responsibility due to proximity. Should you decide to put the home in a trust, you could also opt to add additional assets to the trust for the purposes of funding ongoing costs.

3. How would you facilitate the transfer?

In some cases, adding your heirs to the deed as joint owners of the property can offer a simple solution. But joint ownership can have downsides. One important consideration is that when you own property jointly, with children for example, the jointly owned asset could be subject to the claims of creditors for either joint owner. Consider a scenario where a mother adds her child as the joint owner of the family vacation home. The child then goes through a divorce and the child's divorcing spouse seeks to include the child's interest in the home as marital property.

There can also be tax implications to joint ownership. Typically, adding a child as a joint owner to property is treated as a gift (unless the child pays fair market value for the property). And once the older joint owner passes away the basis of their interest is adjusted to the date of death value, while the surviving joint owner interest is not adjusted. This can subject the surviving owner to capital gains tax if the property is sold.

Another option is to pass the home through a will. But that can become complicated if the house is located in a different state from your primary residence, since your heirs would have to go through probate in multiple states. "That can add to delays in the probate process, which can be a lengthy process to begin with," notes Christy. You may want to check if yours is one of a handful of states that offer a transfer on death (TOD) option, which essentially allows the property to be automatically transferred outside the probate process.

For owners who want to maintain control over how the home is used, both now and after their death, putting it into a trust can offer several advantages, explains Christy. The trust can set forth certain general parameters concerning who has the right to use and enjoy the property, under what circumstances, and whether rent (or other payment) can be charged. Additionally, the grantor can create a side letter that can aid the trustee that is managing the property and provide nonbinding instructions on how to administer the property. Since assets in a trust typically don't pass through probate, this can be a good option for a home that's located in a different state.

4. Should you structure the transfer around estate tax considerations?

Given the expected upcoming adjustment to the estate tax exclusions, families may want to consider putting a structure in place that can help facilitate a tax-efficient transfer down the road, explains Christy. One option is to transfer ownership of the property into a limited liability company (LLC) and gradually pass shares of the LLC to their heirs or into a trust, up to the amount of the annual gift tax exclusion. The LLC structure can also help protect the family's assets against potential liability claims.

Another option is a qualified personal residence trust (QPRT), which allows the property owner to transfer ownership of their personal residence or vacation home into an irrevocable trust. At the same time, the owner can remain living in the home for a term of years, and potentially longer. A QPRT removes the value of the home and the potential appreciation from the grantor's estate, while consuming only a fraction of the gift tax that would otherwise be applicable had the gift been made outright, explains Christy. A downside of a QPRT structure: If the homeowners die before the end of the term, the value of the residence gets pulled back into the estate for estate tax purposes.

Keep the conversation going

Even if you don't expect to pass on your vacation home anytime soon, it may be worth having a conversation with your heirs in the near future to gauge their response. "The process itself can elicit reactions that can help you fine-tune your plans," Christy says. You'll also want to revisit that plan periodically as your family evolves. After all, it's important to preserve a legacy of family harmony—no matter who might ultimately become the owner of your vacation home property.

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This information is intended to be educational and is not tailored to the investment needs of any specific investor.

Fidelity does not provide legal or tax advice. The information herein is general and educational in nature and should not be considered legal or tax advice. Tax laws and regulations are complex and subject to change, which can materially impact investment results. Fidelity cannot guarantee that the information herein is accurate, complete, or timely. Fidelity makes no warranties with regard to such information or results obtained by its use, and disclaims any liability arising out of your use of, or any tax position taken in reliance on, such information. Consult an attorney or tax professional regarding your specific situation.

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