Vacation properties and second homes are, for some, the pinnacle of the American dream. Many people work their entire lives to afford a North Carolina beachfront home or a cabin in the Blue Ridge. Those who obtain a second home anticipate that this property will be passed down to their children. For this reason, it is important to establish a plan to legally protect the property from probate, the debt of future heirs, and over-taxation.
What is the best way to protect my vacation home?
A trust is the best way to protect your vacation home. This legal agreement allows you to lay out your wishes clearly for how the property should be handled once you die. You can use a trust to determine who gets your vacation home, when they have access to it, and what they can do with the property.
Additional benefits of using a trust
One of the many benefits of placing your vacation home in a trust is that anything owned by the trust does not need to go through probate upon your death. For a quick reference, “probate” describes the five-step legal process that your estate must go through before it can be transferred to your inheritors. The goals of probate are to satisfy the creditors to whom the deceased might owe debt. Further, probate ensures that the property is divided up according to the deceased’s will, or according to the law if there is no will. Probate abides by the following steps in North Carolina:
- naming your estate’s representative;
- notifying heirs, creditors and the public at large of your death;
- inventorying the estate;
- paying all bills and taxes owed by the estate;
- distributing all leftover property to the beneficiaries of the estate.
Probate is a lengthy and stressful process that can be avoided by placing all of your assets into a trust. When you die, assets that legally belong to the trust will be passed on to your beneficiaries without passing through probate. If you place your vacation home into a trust then your heirs can immediately use your vacation home upon your death, instead of being forced to endure the probate process.
Immunity from debts
If the home is placed in an asset protection trust, then the home cannot be used to pay the debts of individual trustees. For example, you have a vacation home valued at $300,000 and you place the home into a trust. Due to unforeseen medical expenses you accrue $20,000 in credit card debt that you are unable to pay. If you were to unexpectedly die, the credit card company could not try and recoup the money that you owe them by going after your home. This is because the home is owned by the trust instead of you, thus the home is shielded.
The trust also shields its assets from debt of the beneficiaries. If you wanted your son to inherit your beach house but you also know he is likely to declare bankruptcy in the near future, you could place the house into a trust and name him as a trustee. This legal arrangement allows the house to be protected from the claims of your son’s creditors and your son’s trustee status allows him to continue to enjoy the home when you die.
Trusts are tax smart
When a second home is sold, the profit of that sale is subject to a capital gains tax. The rate of that tax is currently 23%. The profit is calculated by subtracting the price you paid for the property (the “tax basis”) from what you sold the property for.
If you gift the vacation property to your children while you are living, the basis is equal to the amount of money the property was purchased for. For example, if you bequeath your children a vacation property purchased in 1950, then the difference between the current market value and the 1950 value will be large. When your children sell the property they will owe the government a significant amount of money via the capital gains tax.
However, the amount your children owe could be minimized if you place the vacation home in a trust. The tax basis of property inherited through a trust is recalculated to the value of the property upon your date of death (this is referred to as a “step up” in basis). If your children decide to sell a vacation home you have left them in trust, the tax basis is likely to be almost equal to the current market value, and they may owe very little in capital gains tax.
To learn more about common estate planning issues, check out our free guide, Estate Planning Pitfalls: The 12 Most Common Threats to Your Estate & Your Family's Future, or to discuss your estate planning concerns, please call our office at 919-443-3035 or use our contact form.