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Second homes speak to what many families value most. They’re a place to gather, spend time together and build memories. And keeping them in the family over generations requires planning, attention to detail and work.
Back in the early 1960s, a young couple living in San Francisco purchased a small cabin on a large piece of land on the coast, two hours from the city. It was, at first, just a getaway for themselves and their four small children, but soon that cabin became a cherished gathering spot for extended family, including aunts, uncles and cousins. Eventually, a series of physical additions transformed the small cabin by degrees into a large, gracious home, with enough room for 50 years’ worth of stored-up memories of summer nights and holiday gatherings.
Flip through the family album to today. The home remains a beloved destination, but the family has grown and so have the complexities of maintaining the property and its traditions. The four children now have adult children of their own. The original matriarch and patriarch are deceased, and the trust they left for upkeep and maintenance is dwindling. After years of exposure to the elements, the home needs a new roof, new siding and other major repairs. Yet those physical upgrades, while significant, are merely symbolic of much larger challenges facing a family that longed for the home to be as meaningful for subsequent generations as it had been for them. Who makes the decision to keep house? Who pays the bills? Who oversees the upkeep? Who gets to use the house, and when?
Would the siblings, who couldn’t match those contributions, feel as if their brother was taking over? Would they begin to feel they had less ownership or access?
It’s a classic scenario faced by many families that come to view their beach house, mountain retreat or European villa as something more than just a vacation home and almost an extension of the family. It can be a touchstone for precious memories during the kids’ formative years—a symbol of the family’s shared love and values. But as families expand and new generations arise, unresolved questions—from big-picture financial issues right down to who sweeps the floors—can gather like moss under the eaves.
In the case of the northern California house, the four siblings had pursued careers with varying levels of financial success. For some, the prospect of restoration and maintenance costs loomed as a heavy burden. However, one son had done well enough in business that he had the means to preserve the home in perpetuity by himself for the rest of the family. His wife was fully on board with the idea. But their generosity and good intentions created another potential pitfall: Would the siblings, who couldn’t match those contributions, feel as if their brother was taking over? Would they begin to feel they had less ownership or access, or a diminished spiritual hold, on a place they considered partly theirs? Would they begin to feel like visitors in their own vacation home?
To head off those concerns, the couple arranged a gathering of siblings and their spouses, plus nieces and nephews, at which they explained their motives. “They didn’t want to come in as ‘deep pockets,’” says Stacy Allred, head of The Center for Family Wealth Dynamics and Governance at Merrill Lynch™ who worked closely with the family and helped organize and run the meeting. “They wanted it to be collaborative. The biggest priority was maintaining family unity. They didn’t expect preferential weeks in the home, or an extra vote on matters pertaining to the house.” With all of the motivations on the table, the rest of the family saw the offer as a sincere effort to preserve something of enormous value to everybody.
Working with the couple’s accountant and estate planning attorney, Allred helped coordinate a strategy to create a trust to cover major capital improvements, ongoing maintenance, and taxes. Because the trust was structured to receive gifts as “current” gifts (the recipients technically had the right to withdraw the gifts from the trust within a limited window and use them for their own purposes), the couple was able to use their annual gift tax exclusion to fund the trust without having to cut into their lifetime gift tax exemption limit. In 2018, the government allows each person annual tax-exempt gifts of up to $15,000 per individual recipient, so the brother and his wife were able to give a total of $30,000 to each of 18 different relatives, or around $540,000 total.1 And the couple can repeat this process each year until the trust has reached a level capable of maintaining the home for decades to come.2
Your private wealth advisor can help you determine whether keeping that family retreat in the family is really worth all the effort.
Is your family retreat really worth holding on to? It’s a question that often elicits an automatic, almost reflexive “Yes!” But families may have trouble gaining a clear, objective view of the true costs and benefits involved, due to what’s known as “the endowment effect”— the tendency for people to inflate the value of things they own.
For that reason, before families definitively move ahead with a vacation home transfer plan, they check in with their private wealth advisor, who has specialized software for analyzing the true costs associated with the home. These costs may include not only the mortgage, taxes, maintenance, and the like, but also less obvious costs, such as travel to get there, or boats and other recreational equipment that must be bought and maintained. When an advisor has calculated the full amount, he or she can examine other potential uses of the funds and then help families think through the financial aspects to make an informed decision.
Of course, at that point, the family will still need to weigh the financial liabilities and the family’s emotional attachment to the home, but this is a good place to start.
While every family situation is unique, the case of the California compound highlights a universal point about the intergenerational issues surrounding the family vacation home: They should be handled with the same attention to detail you’d bestow on the succession of a family business. That may seem counterintuitive, since a family retreat, by its very nature, is supposed to be about letting your hair down. People tend to think that a place of relaxation and fun is a place without rules, but a place of anxiety and uncertainty isn’t fun, and that’s what having no rules can create.
As a family begins to grow and it begins to think of how to preserve the home as a legacy, one essential step is to create a formal master plan for the home, says Wendy Goffe, a Seattle-based estate attorney and author of a number of highly regarded technical papers on vacation home management, including the classic “Planning for Residences and Vacation Homes.”
The master plan is a sort of constitution for the vacation home, presenting a clear mission statement for what the home means to the family, what they see as its long-term future and how it will be handed down. This may involve an outside facilitator interviewing family members and helping to crystallize everyone’s views into a set of guiding principles for the property. Is this a place of solitude, contemplation, and intimate gatherings of immediate family members, or of frequent entertaining? Will the family develop the property further, or is the overriding aim to maintain its pristine simplicity? What priority does the family place on preserving the home’s natural setting? It’s important to have buy-in from all family members. Even the youngest members can contribute to the process, for example, by coming up with ideas to make the home more “green.”
Perhaps the most vital function of the master plan is to establish clearly how the property will transfer from one generation to the next.
The master plan provides the direction needed to then draft the detailed, specific rules governing issues ranging from finances to whether wet bathing suits are allowed in the living room. There are no right or wrong answers in these matters, but families shouldn’t assume that everyone understands the boundaries. Families that are successful at maintaining respect for the values tend to print out explicit rules. Some families actually post laminated rules in every bedroom of the house. (See “The Rules for the Rules,” next page.)
Since extended families may be spread across the country or around the world, create an online calendar that members can access through a file-sharing application so people can request times for the home, and everyone knows who’s using the place and when. The calendar can include maintenance schedules and track routine expenses. The whole point is to create explicit communication and accountability for things that are going right, and wrong. If one person is doing an outsized portion of the work, others can see that and step in.
Perhaps the most vital function of the master plan, though, is to establish clearly how the property will transfer from one generation to the next. The choices are wide, depending on a family’s priorities and concerns. A private wealth advisor—together with estate specialists, the family’s attorney and their accountant—can help determine which method suits their needs, depending on the age and readiness of the rising generation to manage the operations of the home, the earlier generation’s desire to hand it off or maintain a stake, everyone’s financial needs and the income and transfer tax consequences of a gift during life or at death.
The easiest and most straightforward way to hand the house down is through an outright gift while the owners are still alive. It’s relatively easy, inexpensive and can require minimal paperwork. There are potential tax benefits as well, depending on whether a donor has used his or her federal and state gift tax exemptions. At the federal level, gift and estate taxes both stand at 40% for amounts over $11.18 million in 2018,3 and many states have estate and/or inheritance taxes that should be considered. If a donor has already used his or her exemption amount during life, then any additional outright gifts subject to the 40% federal gift tax may be beneficial if you believe you will owe estate tax in future. That benefit is analogous to being able to invest pre-tax versus post-tax dollars into a retirement account: When you write a check to cover gift taxes, you can simply pay the amount out of whatever available resources you have and can reduce the amount of your taxable estate. But if you leave the home in your estate and wish to have your estate cover the tax bill, you may be drawing on funds that have already been nearly halved by the transfer tax since that amount would be part of your taxable estate. Note, however, that other estate planning strategies may be available and may be more tax efficient. Consult your tax advisors regarding these strategies.
One approach that may help ease the tax burden is forming a qualified personal residence trust (QPRT). When you establish a QPRT with a term of, say, 10 years, you give the house to the trust, thus removing it (and all of its future appreciation) from your taxable estate. During the term of the trust, you continue to use the home and pay taxes and other regular expenses. Once the term expires, the beneficiaries become the owners of the property, and from then on, whenever you use the property you must pay fair market rent.4 Because you retained use of the property during the life of the trust, its value can be reduced according to an IRS formula for the purposes of determining the gift tax.5 The longer you retain the right to live in the house the smaller the upfront gift. Thus, grantors are often tempted to create long-term qualified personal residence trusts. But there’s a catch: If the grantor dies before the trust term expires, the home reverts to his or her taxable estate. “The tax savings can be significant,” Goffe says, “but to make it work you have to outlive the trust, so there’s a bit of uncertainty.”
Another drawback to an outright gift or QPRT is loss of control over a place that holds emotional value. In the case of a QPRT, the former owner may find it irksome to pay fair market rent topping $15,000 a week for a Martha’s Vineyard or Sun Valley retreat that still psychologically feels like home. Loss of direct control may lead to other frustrations, as well. While the kids may say they value their parents’ guidance and will work out any disagreements peacefully, once the home is out of the previous generation’s hands, they are under no formal obligation to do so. For some parents, according to Goffe, this can lead to a sense of regret that they didn’t just wait to pass on the property after their death, so at least they wouldn’t have had to witness the resulting squabbles. That said, not all control is lost. If parents are the trustee then during their lifetime they can sell the home and replace it with another.+
No matter how unnecessary they seem, a strong set of rules provides the clearest path to vacation home harmony.
“We’re so close, we don’t need formal rules.” That may be the single most dangerous sentence a family can utter as it attempts to maintain a vacation home across generations, family wealth experts say. Issues can arise among the closest families, says Jeralyn Seiling, managing director and wealth strategist in the Private Banking and Investment Group. “It’s not just big issues, like who writes the checks. Often, it’s little things, like who forgot to clean out the refrigerator.”
Families need to create a clear, detailed set of rules covering even minor procedures. While each family’s list will vary, here are some potential flash points, along with some sample rules for addressing them.
Despite the family’s best efforts to
portion out choice weeks fairly, conflicts are bound to crop up.
What happens when one family member’s 4th of July week is washed
out by rain and they want a do-over?
• Sample rule: “Since nobody controls the weather, each member takes his or her chances in choosing weeks.”
One visitor’s bedtime snack
may be the next visitor’s ant attack.
• Sample rule: “Food may not be taken into any of the bedrooms.”
sense of order throughout your stay helps remind families to take
care of the property.
• Sample rule: “We wash the dishes at the conclusion of each meal.”
families, the home is a place of solitude and quiet gathering of
loved ones; for others, it’s a way to spread the love among
neighbors, coworkers and friends.
• Sample rule: “We welcome all family members. (Friend time should be at a different venue.)”
Even small surprises can leave bad
• Sample rule: “Before departure, check under all seat cushions.”
To retain greater control and potentially provide for a more seamless transition, families may choose to transfer ownership of the home to a family limited liability company (LLC). The grantors may then gift shares in the LLC as a way of transferring ownership. There’s also a tax benefit. While distributed shares are subject to gift taxes, because multiple people have shares, individual recipients don’t control the property and can’t turn around and sell it. The value of their gifts can thus be discounted accordingly for transfer tax purposes.
The truth is, no matter how carefully plans are drawn, no matter how much love a family has for one another, sharing a second home and maintaining traditions across generations is never easy.
An LLC offers the flexibility to maintain or share decision-making responsibility as you see fit. As with a family-owned business, you might, for example, decide to distribute nonvoting shares to the kids, giving them a financial stake in the house while withholding their vote in major decisions until you feel the time is right. Even if you give away all of the financial shares, you could still retain partial or full voting authority.+
Whether you use an outright gift, QPRT, LLC, another trust vehicle, or some combination of the above, regular annual “shareholder meetings,” while not a requirement of any of these structures, are strongly recommended, says Goffe. “That’s when you review the family values that surround the house, the rules, and update them as necessary, and generally perform your organizational upkeep for the year,” she says.
Of course, a good transfer plan should also include an exit strategy for any family member in a succeeding generation who wants out. They may have settled in another part of the world and can’t use the place. Or they may find themselves in need of liquidity. “Locking everyone together can lead to resentment when someone has a reversal of fortune and suddenly needs cash,” says Seiling. Structuring of the escape mechanism varies according to each family’s financial situation. “Often, when one family member wants out, other family members will have an automatic right of first refusal to buy their share,” she says. To prevent remaining family members from facing a steep bill all at once, the plan may stipulate payments to the departing member take place in installments over time. The subject of divorce should be raised. Families do not want to see a percentage interest owned by a disgruntled ex-spouse of a family member.
The truth is, no matter how carefully plans are drawn, no matter how much love a family has for one another, sharing a second home and maintaining traditions across generations can have its challenges.
The truth is, no matter how carefully plans are drawn, no matter how much love a family has for one another, sharing a second home and maintaining traditions across generations can have its challenges. It’s the rare family that can sidestep the challenges involved altogether. Allred recalls one wealthy family, based in Hawaii, with three separate retreats: a luxury beachfront house, an inland ranch and a ski home on the mainland. The couple had three children, each with different temperaments and interests. One daughter was interested in sustainable farming and, naturally, gravitated toward the up-country ranch. The son wanted the beachfront property, and the other daughter wanted the ski lodge. By having a learning conversation, they were able to align each sibling’s preference to their estate plan. Working with their attorney, they added a right of first refusal for each property into their testamentary giving.
For the rest of us, the family vacation home becomes another of those ties that, for better or worse, bind us together but, with proper planning, maintenance and attention to detail, can make our lives all the richer.
When it comes to navigating the use of a vacation home among multiple family branches, recording current practices that work is crucial and planning for the future is essential. A family cabin policy collaboratively developed by your family provides guidelines for enjoying the home individually and as a family, safeguarding relationships and planning for future transitions or changes. Here’s what the policy might include:
We value building family bonds and memories by:
We will support these values by:
We will practice our ethos and etiquette by:
Family members can balk at developing a policy when the process feels like a sudden, large commitment. Starting with small steps can increase the likelihood that everyone will agree to, and comply with, a policy.
For example, consider a famous study6 by Stanford researchers where a group of homeowners was asked to put a large sign in their yard that said “Drive Carefully.” Only 17% agreed. For a second group the researchers first asked people to put a small sign in their window encouraging safe driving. Most of the group agreed to the small sign and, a few weeks later, 73% agreed to the large “Drive Carefully” sign.
Your family can start with a policy with only a few key guidelines and call it a “draft” policy, which can then be followed by stronger commitments the following year or two.
This sample policy was co-developed by The Center for Family Wealth Dynamics and Governance at Merrill Lynch™ and Behavioral Finance and Goals Based Consulting at Merrill Lynch.
1 Rates are adjusted annually for inflation, and these represent 2018.
2 Please note unequal contributions by beneficiaries can create unintended gift tax consequences.
3 The federal estate, gift, and generation-skipping transfer tax rate remains at 40%. The transfer tax exemption amount was recently doubled from $5 million adjusted for inflation ($5.49 million in 2017) to $10 million adjusted for inflation ($11.18 million in 2018), but will return to $5 million adjusted for inflation after 2025.
4 To remain compliant with IRS regulation, fair market rates must be based on rents charged for comparable properties in the same area. If the IRS determines that a property has been rented for a below-market rate, the QPRT may be invalidated, with the property returning to the grantor’s taxable estate, thus wiping out the QPRT’s tax benefits.
5 In a QPRT, the value of the home is reduced for gift tax purposes based on a standard federal discount rate intended to represent the revenue that would have been generated had the parents not retained use of the home. Because this rate is tied to U.S. Treasury rates, QPRTs tend to lose some of their appeal during periods when interest rates are exceedingly low, as they have been recently. Conversely, when rates rise, QPRTs can help garner bigger gift tax savings and gain attractiveness as a transfer tool.
6 J.L. Freedman and S.C. Fraser, “Compliance Without Pressure: The Foot-in-the-Door Technique,” Journal of Personality & Social Psychology, 1966.
+ Donors should consult with their tax advisors to ensure that they do not retain an interest or power that could cause estate inclusion for transfer tax purposes.