Do I Need a Trust for My Vacation Home?

Estate planning for vacation homes, commonly referred to as family cottage planning, is a hot button issue that many of my clients prefer to avoid. But, real estate seems to be the most litigated asset and therefore the most common reason why many families have a falling out after the death of a loved one.

Vacation homes, in particular, are among the most contentious issues because, unless there is a plan in place, there is often disagreement over how the property should be handled and passed down to the next generation.

So the question becomes: 

“How do I make sure the place that created our most cherished family memories does not become the ground zone for World War III?”

There are a few ways to approach this question, so let’s go through your options:

Do I need a trust to protect my vacation home?

A trust tends to be the more common approach and solution to family cottage planning, because it makes sure the property avoids probate – a public court process. On a side note: if your vacation home is located in a state different from your state of residence (aka your “domicile”), then failure to place the property in the trust could result in a dual probate scenario – yes, it is as bad as it sounds.

But beyond avoiding Probate, the trust allows you to designate one or more persons to be in charge of managing the property and following your instructions. And your instructions can be as specific or broad as you’d like.

For example, you could spell out how expenses will be allocated, how time slots will be shared and prioritized, whether the property could be rented when other family members are not using it, the guest policy, and other roles and responsibilities associated with maintaining the property for generations to come.

More importantly, you can also spell out what happens if there is tension or disharmony among family members. Whether certain family members would have priority to buyout other family members, or when the property itself should be sold and distributed in a certain manner to avoid making matters any worse.

But there are alternatives / variations to the trust solution that you may also want to be aware of.

Should I place my vacation home in an LLC (a limited liability company)?

A limited liability company has some advantages over a trust in certain circumstances. For one, you can gift LLC shares in small fragments over time, which could be a useful gifting strategy for families whose estate may otherwise be subject to the federal estate tax (or generations skipping transfer tax).

An LLC can also guard against certain liabilities for assets held in the company name. So, for example, if a lawsuit arose during the course of business of the LLC, then the liability will be (generally) limited to whatever the LLC owns and would shield your personal assets. 

There is a major caveat for LLCs, whish is that if the liability stems from your own personal actions, then you could be sued individually (meaning outside the protections of the LLC), but that’s a blog post for another day.

Similar to the trust document, the LLC will have an operating agreement, which will do exactly what it sounds like - create terms and conditions over how the property should be operated over a certain period of time among the group of owners.

In other words, the operating agreement will provide instructions for how the property should be managed among family members, and lay out the consequences if/when someone fails to abide by the agreement.

But what if I just want to add my kids to the deed?

Some clients, prior to speaking with me, will try to bypass the legal formalities of a trust or an LLC by simply placing one or multiple kids’ names on their deeds for the vacation property.

This is generally a bad idea for 3 reasons:

1. Increase exposure to creditor risk - now that all their names are on the deed if any of them get into financial trouble (e.g., bankruptcy, lawsuits, or divorce), then the property could be caught up in the mix.

2. Loss of control - since you are no longer the sole owner of the property, if you want to ever refinance it or do any major changes to the property, then you have to first get consent from your kids first.

3. Loss of step up in cost basis – I’m not going to bore you with all the details, but the general idea is that if you were to die with the property within your estate (whether it’s titled in your name individually, in a grantor trust, or in an LLC that you own), the property’s cost basis would reset to its fair market value as of the date of death. This means that if you hold onto the property and have not gifted it to your children, then they would save thousands (sometimes hundreds of thousands) from income taxes. Whereas if you had gifted the property, then your children’s portion would not receive a step up in basis and they would not get the full extent of those income tax savings benefits.

If you’d like to learn more information about common traps to avoid when family cottage planning, then you may want to check out one of our other articles: 3 Things You Need to Consider for Family Vacation Home Succession Planning.

Need help with your estate planning?

If you would like to review or update your estate plan, then give me a call at 781 202 6368, email jlento@perennialtrust.com, or click here to schedule your free personal consultation.

I’m always happy to help!

Joseph M. Lento, J.D.

Your Local Estate Planning Attorney

www.PerennialEstatePlanning.com

477 Main Street

Stoneham, MA 02180