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

A Further Look at Portability

As we discussed last week, there are benefits to the concept of portability in estate planning. However, portability has several limitations.

1. The unused Generation Skipping Tax (GST) Exemption of the spouse dying first is not portable and will be lost if not used. A client who wants to leave assets in trust for the benefit of future generations more remote than the first generation below the client’s will want to use a trust to take full advantage of the GST exemption.
2. Assets passing outright to the surviving spouse likely are subject to the claims of creditors of the survivor, including any subsequent spouse in a divorce. Placing property in trust provide better protection from such claims.
3. A trust provides independent management of the assets, protecting them from the unwise decisions of the beneficiaries. Even clients who believe that their spouse and children are competent managers may want to consider this benefit, because it avoids the potential adverse influence of unwise friends and in-laws.
4. As discussed previously, to secure portability the surviving spouse must file an estate tax return, even if one otherwise would not be due, and that may increase the costs of administering the estate of the first-deceased spouse.
5. The DSUE (Deceased Spousal Unused Exemption) amount is not indexed for inflation. Property passed via credit-shelter trust instead of relying on portability, may appreciate at a rate equal to or greater than inflation, allowing a greater amount of assets to pass free of estate tax when the surviving spouse dies.

        When counseling married couples who expect their combined wealth to fall well below the combined sum of two estate tax exemptions it may take several conversations to reach a decision about whether to use a credit-shelter trust or to rely on portability. In this situation, one option some may choose is to leave the entire estate to the surviving spouse but provide that to the extent the survivor disclaims the bequest, it will pass into a credit-shelter trust for the surviving spouse and, perhaps, for the couple's descendants.        Disclaimer planning that arguably does not save taxes may be a tough decision for a surviving spouse. Counting on the surviving spouse to disclaim in this situation and give up control of the assets may prove foolish.  In client discussions, consideration must be given to the benefits of a basis step-up on the second death.

Most Wills for married couples should now address the question of whether the executor should be required to elect portability, or be given discretion to elect portability. The document should reflect who should pay for the cost of the estate tax return, if it is filed solely to elect portability.  A married taxpayer who plans to use portability should direct his or her executor in his or her Will to file an estate tax return and make the election. Otherwise, the executor may decide not to incur the cost of filing the return

Portability also may become an important discussion for a provision in a prenuptial or postnuptial agreement, to ensure that the surviving spouse is required to use portability to minimize estate taxes on the first death, maximizing estate tax savings on the second death.

As with all estate planning options, the use of portability should be carefully reviewed with clients to make sure that the client takes into account not only estate tax savings, but also their own needs and desires. 

Alan Ferrara