Unintended consequences can occur when dividing up real property, which is often harder to distribute than investment accounts or savings accounts. Planning for real property division must take into account the different circumstances of your heirs.
You may have envisioned a time in the future, when your children and grandchildren enjoy the same lakeside home as you have for years after you’re gone, and are pleased with the idea of leaving the family vacation home to the next generation. But think again, says a recent article in Financial Planning, “Save clients from tax pitfalls, family strife when passing on that lake cabin,” because your vision may not translate into reality.
Some of the kids may be attached to the family vacation home and want to keep it. If possible, the best solution is a buyout among the siblings. That’s not as simple if finances don’t allow it, and the sentimental siblings are forced to sell, resulting in hard feelings. Another option is to put the vacation home in an irrevocable trust to remove it from the estate.
In addition to a need for cash, one heir may reside too far away to enjoy the home regularly, another heir may have a spouse who doesn’t want to use the vacation home or another heir may be unmarried without children and has no need for a large vacation home. Family discussions should take place while original vacation homeowners are still alive and healthy, in order to eliminate a great deal of frustration and stress.
Remember, a vacation home sale doesn’t qualify for the $250,000 capital gain exclusion (or $500,000 for married couples filing jointly) that can apply to the sale of a principal residence. A large gain on a vacation home might be taxed at the top 20% rate on long-term capital gains. There’s also the 3.8% surtax on net investment income, as well as the potential for state income tax. But maintaining the vacation home and leaving it to the heirs as an inheritance, doesn’t create an income tax bill because there’s step-up basis to the date of-death value. This wipes out the capital gains tax on prior appreciation.
When the kids are older, family discussions while both parents are alive can help make estate planning decisions that everyone likes. The kids might want to share the house and maintain it. If one child isn’t as financially secure as the other, he may want to inherit cash rather than the property. If that’s honored by the parents, they can state in their estate plan that one child will get the house and the other will get an equivalent value of other assets. The real estate appraisal can take place at the time of death. Frequently, one child purchases the family home from the estate of the parents, and other siblings buy their own vacation home—perhaps with their own inheritance. This makes everyone happy.
There are a variety of ways to leave the vacation home to the next generation, including creating an irrevocable trust that takes the property out of your estate. This could lead to capital gains issues for your heirs, who will lose the basis step-up. It may be possible to decant the trust, or move the assets to a new trust, with different terms.
An experienced estate planning attorney will be able to help you figure out the most realistic way to share your favorite country home in such a way that will not create a hardship for family members.
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