Keeping Family Vacation Homes in the Family

A warm day like yesterday often triggers thoughts of summer and good times at the family cottage. With these thoughts in mind, clients often wonder how to structure the transfer of ownership of a family vacation home to their children and grandchildren either during lifetime or at death.

     Gifting or bequeathing a family vacation home is not an easy matter and requires significant planning in order to treat all family members fairly. Clients need to balance their desire to make a well-intentioned gift with the possible unintended burden on beneficiaries, which may cause strife among loved ones. Additionally, the transfer of such high-value assets brings with it potential estate and gift tax implications. While a client certainly must consider tax issues and the possibility of an increase in property taxes because of the transfer, we will leave these for another time and focus primarily on the family issues. 

     While a parent may hope that common ownership of a vacation home will keep their family together, it is entirely possible that not all of their children have the same warm memories of summers at the lake. In addition, those children’s spouses and children may have different ideas on how to spend family vacations. Add to all of this the fact that many adult children have moved away to pursue their careers (or avoid sometimes harsh Michigan winters) and may not be able to enjoy the use of a vacation home. It is important to discuss these issues with all of the family members to determine which children are interested in owning a part of the "family cottage".

     While there is not enough time to discuss all of the issues, important points to consider when transferring the vacation home include:

• What will the ownership structure be? This could include ownership jointly, as tenants-in-common, by a trust, or by an LLC?
• Who will manage the property? Family dynamics are important - not all of the family members may want to get involved in the day-to-day decisions.
• How will use of the vacation home be determined?  A plan should be in place for fairly selecting weeks of use for each of the family members.
• How are repairs and improvements, including cost, dealt with? Some family members may always be looking to upgrade the facilities while others may be happy to keep things simple and inexpensive.
• Should there be rules about allowing guests to use the cottage, especially without a family member present?  Allowing many non-family guests to use the cottage can cause considerable wear and tear on it and create friction among family members.
• Is there a procedure for allowing a family member to sell or gift the ownership interest?  Either during lifetime or at death, family members often desire to transfer their interest to a spouse, or children. If not planned for, this can result in a significant fractionating of a family member's interest and increasing the total number of "owners" for purposes of use and expenses. It might also result in pieces of the vacation home being owned outside the intended family.

     While continuing family ownership of vacation property is a laudable goal, much thought should be put into the process to make sure that the intended result of family harmony does not actually result in disharmony. As with any other tax or gift planning strategy is important to understand each client individual circumstances and consult with their professionals to ensure that the planning will not have unforeseen consequences.

Making the Most out of Year End Gifts to Family

This time of year, many of our clients begin considering making gifts to family members. Some of our clients will use the annual gift-tax exclusion ($14,000 in 2013), to make family gifts tax-free. Others, who desire to make larger gifts to family members, are willing to use of a portion of their lifetime exclusion amount (totaling $5,250,000 in 2013).

Many of our clients attempt to keep things simple by giving cash. "Cash makes no enemies" as they say, but it still can remove a significant amount of assets from a client's estate in the event of future estate tax liability. For example, a couple I represent, who will have a taxable estate, give $14,000 each to a total of 33 children, grandchildren, and great-grandchildren, as well as to spouses of some of those beneficiaries. Each year they give away more than $900,000, which will save over $360,000 in federal estate tax liability at their death. I suggested the clients give interests in LLCs holding real estate rather cash because it would have allowed them to give away more than $1,100,000 under their current gifting scheme. Unfortunately, many of their beneficiaries have gotten used to living outside of their means and need these cash gifts to help balance out their annual expenses.

As I mentioned above, clients can get even greater advantage against future tax liability by using the annual exclusion gifts to give highly appreciating property rather than cash. The current value of the gift and any future appreciation escapes taxation. Giving children a portion of real estate or minority interests in closely held companies are two common methods of taking advantage of this technique. In addition, it is possible to discount gifts or a minority interest for gift tax purposes because of lack of marketability and lack of control. For example, using a 20% discount allows clients to treat a gift of minority interest valued $18,000 as a gift valued at $14,000. Depending upon the asset the clients choose to transfer, sometime greater discounts are possible.

Others of my clients have taken advantage of the possibility of discounts by giving awayclosely held stock or minority interests in LLCs, which may hold real estate or other invested assets. Can clients not only leverage the annual exclusion gifts, but also can actually leverage the lifetime estate tax and gift exclusion. If there is a desire, a client can make gifts above the annual exclusion amount by using some or all of their lifetime exclusion. If only a 20% valuation discount is available, the current $5,250,000 lifetime exclusion could support gifts of over $6,500,000, not including future appreciation. One client in particular gave away a 99% nonvoting interest in an LLC holding real estate that is leased by his other businesses. Not only were we able to use discounts because the interest was nonvoting, but his retained 1% voting interest allows him to control the entity. This particular client did not need the income from the leases so we structured the LLC to distribute that income to the children. Another client used a similar strategy and distributed income to his grandchildren for their education expenses.

Even if the clients do not have a taxable estate, making gifts to children may be a good idea because it allows them to see if their children will use or invest the money wisely. If the children make mistakes with small amounts, they can modify their estate planning documents to provide guidance to children after their deaths so assets are not wasted. In addition, it can allow them to enjoy seeing their children do things and have things while they are still alive.

Any time during the year is a good time to make gifts to help facilitate planning, but as the days grow short and the year nears an end, there is a finite amount of time for clients to take advantage of gifting opportunities using the annual exclusion gifts or lifetime exclusion gifts. It is important for us as planners to help clients understand the opportunities and facilitate good planning. We need to remind them that if an annual exclusion gift is not made in any particular year, it lapses and cannot be carried over to a following year.

This time of year is also an excellent time for clients to consider charitable gifts, and next week we will discuss some of the planning opportunities for charitable donations.

Alan Ferrara and Matt Ferrara

Eliminating Unrecorded Deeds

    In past blogs, we discussed the importance of properly funding a Living Trust to ensure that estate plans function as intended. Today's blog addresses a long-standing technique for funding real estate to a trust that has fallen out of favor in recent years, but is likely a part of many long-standing estate plans.

     Holding real estate jointly as husband and wife offers significant protection for the property against the claims of either spouse’s creditors. In the past, attorneys were unwilling to cause their clients to give up this protection with respect to real estate in order to fund a Living Trust while both spouses were alive. To address this issue many attorneys recommended executing a Quit Claim Deed from husband and wife to a Living Trust, but not recording the deed while both spouses were alive. Instead, the client or attorney would put the deed in a drawer (or safe) to record later, if something should happen to both husband and wife. Over the years, many unrecorded deeds were placed in drawers, safety deposit boxes, and safes for Successor Trustees and Personal Representatives to discover. Not only will a creditor's attorney argued that these are completed deeds and therefore the creditor protection of jointly owned real estate no longer exists, but these unrecorded deeds can create a great deal of confusion in the administration of an estate.

     In recent years a form of deed known as a Quit Claim Deed with Reserved Life Estate to Grantor, or more commonly a Ladybird Deed has become more widely used because it reduces the need for unrecorded deeds in estate planning. A Ladybird Deed allows the property owners to establish a lifetime right of ownership in the property, including the right to sell or dispose of the property in any way they choose. If the owners take no other action, at their death the property passes automatically to the person or entity, such as a Living Trust, named in the deed, without the need to pass through Probate. This allows a married couple to retain the creditor protection of jointly owning property while ensuring that their Living Trust ultimately controls the disposition of all their property without the necessity of Probate. This type of deed can also be effective for a single person who desires to avoid probate with respect to real estate, but is not ready to transfer property to children because they may have their own creditor issues or because it is impossible to sell property later without the children's permission.

     In most states (including Michigan), in order to be effective, a Ladybird Deed must contain particular language. For this reason, it is important to seek the advice and counsel of an attorney familiar with property transfers prior to signing any new deeds. Failure to include the correct language may result in unanticipated consequences, including loss of creditor protection, an unexpected transfer of the property, or an unwanted uncapping of the property value for the purposes of determining property taxes.

Matt Ferrara

Passing on Vacation Homes and Cottages

     As the temperature slowly inches upward, indicating the actual arrival of Spring, it is a good time to discuss vacation homes and cottages. These properties are common in Michigan and frequently represent a substantial portion of an estate's assets. With the substantial increase in property values over the past 30 years, long-held vacation properties purchased decades ago now likely have substantial resale value. 

      We posted previously about keeping a vacation home in the family. For those who wish to see a family vacation property enjoyed by future generations there are concerns about the best way to structure such a transfer. Clients need to balance their desire to make a well-intentioned gift that has provided so many positive memories with the possible unintended burden on beneficiaries that may cause strife among loved ones. Additionally the transfer of such high-value assets brings with it potential estate and gift tax implications. While the current estate tax exemption creates a situation where risk of potential tax liability is very low, few people wish to use up any more of that exemption than necessary. Therefore, strategies that take advantage of the annual gift exclusion and allow for transfer of the vacation home over time rather than at death remain popular. 

      One result of a current real property transfer is the possible increase of property taxes for a new owner because the value of the property for determining property taxes may increase following the transfer. Michigan law places limits on the amount that the appraised value of a piece of property may increase for the purposes of calculating property tax liability while an owner continues to own property. The county, however, reassesses the value of the property when the property is transferred to a new owner. This reassessment is commonly known as "property tax uncapping." Certain transfers of property, such as between husband and wife or to the current owners’ living trust, are exempt and do not cause the property to uncap. In addition, as long as a husband and wife own more than 50% of the property, there will be no property tax uncapping. 

      Until recently, the list of exempt transfers did not include the complete transfer of property between parents and their children. While clients could reap potential benefits by transferring real estate during their lifetime (and avoid estate tax at death), the consequences in terms of increased property taxes outweighed the benefits of the transfer. Late in 2012, the Michigan legislature approved a change to the list of exempt transfers that goes into effect on December 31, 2013. Starting on that date, transfers to a first generation blood relative, that is from an individual to their children or to their parents, does not cause the property to uncap for the purpose of determining property tax liability. This new rule allows the transfer of a greater portion of the property to other family members without increasing property taxes. 

     This change creates the opportunity for clients to transfer vacation property to their children, whether via gift or through direct sale, without exposing their children to substantially higher property taxes. Any clients considering transferring vacation homes should wait until the end of the year to do so. As with any other tax or gift planning strategy is important to understand each client individual circumstances and consult with their professionals to ensure that the planning will not have unforeseen consequences.

Matt Ferrara