PNC CENTER FOR FINANCIAL INSIGHT

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1 PNC CENTER FOR FINANCIAL INSIGHT Deciding the Future of the Family Vacation Home How you pass on your family vacation home can greatly influence if it remains a special, positive place for future generations. Learn key considerations and strategies. PNC Center for Financial Insight SM builds bridges from thought to action, creating practical, applicable strategies to help benefit you and your family. Summers at the beach with children and grandchildren playing in the water, clam bakes in the backyard, the smell of sunscreen, and sticky ocean breezes in the air. Vacation homes are often special gathering places where family memories are made, leading many to want to keep them in the family. How you pass on a home to your heirs can greatly influence whether it continues to create a positive bonding environment for future generations to come or if it becomes a financial burden or worse, a hotbed of sibling and other intra-family acrimony. In some cases, it may not make sense to pass the home on at all. If you are thinking about passing on your vacation home 1, it is important to first speak with your heirs to gauge if they want the home, how much they might use it, and if they have the resources to maintain it. You may find if, for example, you have more than one child, that each has a different level of interest and ability to use or maintain the home. Factors including distance to the home, schedules, lifestyles, wealth levels, and commitments will affect how much they might use the property and whether they want to, or can, take on the responsibilities of ownership. ¾ Planning Point - When one or more of your children say they want to own the property after you are gone and others do not: Consider including language in your estate documents, such as your will, allowing your children the right to opt-in when it comes to receiving the vacation home as part of their inheritance. Those opting not to receive their share of the property can receive other assets of equal value. It s important that your children understand that opting in will make them responsible for future expenses; likewise, opting out will make future use and enjoyment of the property unlikely. The Balancing Act It is not uncommon for one member of the family to use the family vacation home more than others. This can become a source of contention among family members even when this is due to factors such as where they live in relation to the property or personal choice. More often than you might think, situations such as an unemployed grandchild living in the home also occur. Balancing the responsibilities and benefits of ownership with multiple family members can be difficult. Having the children engage in an open dialogue about their expectations and setting clear guidelines for use of the home can help prevent misunderstandings and miscommunications that can lead to family discord. Arrangements can 1 This discussion focuses on the vacation home, but these considerations can also apply to other family property.

2 August Example: Balancing the Benefits John and his two sisters, Angela and Susan, are each one-third owners of a beach home in Florida that they received from their mother s estate. John has a stable career, but has limited disposable money. He lives nearby with his wife and three children and expects to often spend time at the property. Angela is a successful patent attorney and lives in Atlanta. She is unmarried and has no children. She also enjoys spending time at the beach home although she expects to spend less time there than John due to its distance. Susan is an executive with a large manufacturing firm and lives in Oregon with her family, including three children. Susan has a busy schedule that prevents her from using the property for more than a week or two a year. To adjust for this inequality of use, the siblings cover the maintenance costs in proportion to their usage and wear and tear on the home. John and Angela share the property taxes with Angela covering a larger proportion. John looks in on the property regularly, coordinates the payment of bills, and hires repairmen as necessary. The use of the property is scheduled ahead of time, and Susan is given priority on dates of usage when they can be accommodated. be informal verbal agreements or more formal written documents outlining use schedules and expense responsibilities. Use of the property does not necessarily have to be equal, but everyone should feel that they are getting some benefit based on their expectations and circumstances. Avoiding the White Elephant Property taxes, maintenance, unexpected repairs, debt service (if applicable) it all adds up. We believe that part of your plan to keep your vacation home in the family should address how to cover its ongoing costs. Know how your children plan to meet these expenses after they become owners. If your children are uncomfortable with having these discussions in a group setting, it may be best to speak with them individually. If they will need additional assets from you to meet these expenses, you should take that into account in your gifting or estate planning. If it becomes clear that your children will not have sufficient assets to maintain the property without significant assets from you, you may want to reconsider your plans to transfer the property. ¾ Planning Point - If you will be passing additional assets to support the property, it is a best practice to place these assets in trust. This allows the assets to be used for ongoing property expenses and not for other purposes. It may be beneficial to have the property itself pass in trust as well. Placing these assets in trust can provide additional benefits, such as protection against creditors and easier administration for covering costs of the home. 2 ¾ Planning Point - The 2017 tax legislation limits the ability to deduct property taxes, combined with other state and local taxes, to $10, Depending on your current tax situation, the 2 For more discussion on the benefits of trusts, see Using Trusts to Help and Protect You and Your Family from the PNC Center for Financial Insight. 3 Internal Revenue Code (IRC) 164(b)(6)(B). This limitation is scheduled to expire on December 31, 2025.

3 August To Keep or Not to Keep Before you decide to transfer the family vacation home to the next generation, we believe it is important to find out the following: Are your heirs interested in owning the property? How much do each of your heirs families think they will use the property? Do your heirs have the resources to cover the financial commitment of ownership? Do your heirs have a good relationship with each other? Do you feel your heirs can work through any issues that occur, for instance, arising from different amounts of use of the home or ability to cover costs? additional property taxes on the vacation home may not provide an income tax benefit. Holding the property in a taxable trust (one that pays its own income tax) may enable the trust to utilize this income tax deduction. Note: Placing assets in trust should be done in light of your overall planning goals. In our opinion, assets should not be placed in trust solely for the property tax deduction. Prepping for Shared Ownership If the property is not already owned in an entity, such as a limited liability company (LLC) or family limited partnership (FLP), you may want to consider doing so now. These entity structures can serve as a convenient way to pay bills and hold assets for future expenses, as well as formally outline rights and responsibilities for each owner. These types of structures can also protect the family s other assets from liability exposure. For example, if someone is injured on the property and decides to sue, having the property in an entity can protect your other assets, including your residence and investment portfolio, if the case is decided against you. An additional benefit of owning the property inside an entity is when the time comes to transfer ownership to the next generation, should that be desired, transferring a partial ownership of an entity that owns the property can be more easily done than transferring a partial interest in the property itself. Owning the property inside an entity does add an additional layer of administration, including setting up the entity and ongoing reporting responsibilities, including tax returns. ¾ Planning Point - If your vacation home is in a state other than where your primary residence is located and it is owned in your name, your estate would need to go through a probate process known as ancillary probate. This can be a time-consuming administrative burden. Placing the property in an entity, such as an LLC or limited partnership, or in trust would eliminate the need for ancillary probate. Timing is Everything There are three primary ways for you to pass your vacation home on to your heirs: during your lifetime as a gift; after your death as part of your estate plan; or as a future interest gift. While it is common to consider making gifts during your lifetime or after your death, the future interest gift combines some of the benefits of both of these strategies. The future interest gift works particularly well for gifting real property, including your vacation home.

4 August A future interest gift will allow you to have unlimited use of the property for some time, lower the amount of gift tax exemption a transfer would use, and help ease concerns about your family members ability to cover initial ownership costs. Future interest gifts are generally accomplished through a trust known as a Qualified Personal Residence Trust (QPRT). This trust allows you to transfer the property at a future date at a lower gift value than if you gifted it straight away. You will continue to pay all property expenses and can have unlimited use of the property during the trust term, which is set by you when the trust is established. Trust terms are generally between 10 and 15 years. At the end of the trust term, the property passes to your heirs. Internal Revenue Service rules 4 prevent you from using the property after the trust terminates unless you pay market rent. Some find that paying rent is an effective way to provide assets for future property expenses although it may have income tax implications for the children. It is important to note that if you die before the QPRT term expires, the value of the property is included in your estate as if the QPRT did not exist. Your main concerns and objectives will influence which transfer method may be best for you and your family. Below are some issues and goals for you to consider: Providing Advice and Guidance If you feel that your family could benefit from your advice and guidance during the ownership transition process, you may want to consider transferring the property sooner rather than later. Transferring during your lifetime, either by gift or through a future interest gift, can enable you to participate in the transition process. You can lend a guiding hand as the children hammer out the shared ownership arrangement and be the voice of experience when it comes to maintenance and upkeep needs. This can help your heirs have the best chance to succeed as owners. Tax Minimization If the property has appreciated substantially or you expect it to appreciate substantially during your lifetime and you anticipate your heirs might decide to sell it at some point, you may want to consider passing the property after your death. While gift taxes and estate taxes are no longer a concern for most families 5, the method of transfer you choose can affect the capital gains taxes for your heirs if they sell the property. Assets passing through an estate will receive a basis step-up at death while assets passing during your lifetime will not. The basis step-up eliminates any unrealized capital gains in the property. 6 Finding Flexibility Families change, and their needs and desires can change as well. If there are uncertainties regarding the prudence of transferring the property, you may want to include the property in your estate plan. This can provide you and your heirs the gift of time: Time for you to adjust your estate plans based on changed needs, and if necessary, time for your heirs to prepare themselves, financially or otherwise. 4 Treas. Reg (c)(9) (1997). 5 The lifetime gift exemption and estate tax exclusion of $11.18 million ($22.36 million for a married couple) are enough to eliminate the risk of gift or estate tax liability for all but a few families. 6 For more information, see Strategies to Help Your Heirs Enjoy More of Their Inheritance: Basis Planning from the PNC Center for Financial Insight.

5 August Transferring Your Vacation Home Method Benefits Considerations Future appreciation is removed from your Possible gift tax implications taxable estate Lifetime Gift (A straight-out gift) Estate Bequest (After Your Death) Future Interest Gift (when you set up a QPRT and agree to gift the asset when the trust terminates.) You are still available for advice and guidance during the transition process Capital gains exposure can be significantly decreased due to step-up in basis You can adjust for changes in family circumstances that occur before your death Retain your legal right to unlimited use of the property until your death Retain legal right to unlimited use of property before expiration of the trust Can provide a means to transfer additional resources through rental income after expiration of trust Your use of the property will no longer be unlimited Higher capital gains exposure for your children if they sell the home Possible estate tax implications Ancillary probate if property is located in another state Administering the estate may be time consuming and costly Includible in taxable estate if you die before expiration of trust Adjustment for future changes in family circumstances is not possible Selling the Property After weighing your options, you may decide that transferring the property to your children may not be the best idea. If you want to continue to use the property for the rest of your life, you can instruct that the property be sold in your estate after your death. This will not incur any capital gains tax, as discussed above. Selling your vacation home while you are alive can have significant income tax implications depending on the unrealized capital gains. However, you can still eliminate some or all of the gains if you make your vacation home your primary residence prior to its sale. ¾ Planning Point - The tax code allows couples who file jointly to exclude up to $500,000 of capital gains ($250,000 for single filers or married filing separately) from the sale of a primary residence. 7 To qualify for this exclusion, you must have owned the residence and used it as your primary residence for at least three of the last five years. While many vacation homes will not meet this primary use test, you may want to consider making your vacation home your primary residence for three years before selling it. Depending on the amount of capital gains you can avoid, the potential savings could be significant. Owning a vacation home can be a great thing for a family. However, what s good for you may not be as good for others. Understanding your children s desire and ability to own the property after you are gone can guide the decisions you make today and in the future. These decisions can help preserve the special place the home has within the family and build a foundation for additional memories to come. 7 IRC 121.

6 August For more information, please contact your PNC advisor. The PNC Financial Services Group, Inc. ( PNC ) uses the marketing name PNC Center for Financial Insight SM to provide wealth planning education to individual clients through its subsidiary, PNC Bank, National Association ( PNC Bank ), which is a Member FDIC. Standalone custody, escrow, and directed trustee services; FDIC-insured banking products and services; and lending of funds are also provided through PNC Bank. This report is furnished for the use of PNC and its clients and does not constitute the provision of investment advice to any person. It is not prepared with respect to the specific investment objectives, financial situation, or particular needs of any specific person. Use of this report is dependent upon the judgment and analysis applied by duly authorized investment personnel who consider a client s individual account circumstances. Persons reading this report should consult with their PNC account representative regarding the appropriateness of investing in any securities or adopting any investment strategies discussed or recommended in this report and should understand that statements regarding future prospects may not be realized. The information contained in this report was obtained from sources deemed reliable. Such information is not guaranteed as to its accuracy, timeliness, or completeness by PNC. The information contained in this report and the opinions expressed herein are subject to change without notice. Past performance is no guarantee of future results. Neither the information in this report nor any opinion expressed herein constitutes an offer to buy or sell, nor a recommendation to buy or sell, any security or financial instrument. Accounts managed by PNC and its affiliates may take positions from time to time in securities recommended and followed by PNC affiliates. PNC does not provide legal, tax, or accounting advice unless, with respect to tax advice, PNC Bank has entered into a written tax services agreement. PNC does not provide services in any jurisdiction in which it is not authorized to conduct business. PNC Bank is not registered as a municipal advisor under the Dodd-Frank Wall Street Reform and Consumer Protection Act ( Act ). Investment management and related products and services provided to a municipal entity or obligated person regarding proceeds of municipal securities (as such terms are defined in the Act) will be provided by PNC Capital Advisors. Securities are not bank deposits, nor are they backed or guaranteed by PNC or any of its affiliates, and are not issued by, insured by, guaranteed by, or obligations of the FDIC, the Federal Reserve Board, or any government agency. Securities involve investment risks, including possible loss of principal. PNC Center for Financial Insight is a service mark of The PNC Financial Services Group, Inc The PNC Financial Services Group, Inc. All rights reserved.