Vacation property and “second homes” – whether in the mountains or at the beach – present a number of legal and tax planning opportunities.
A little secret: Most of what you’ll read here also applies to your residence.
Avoid Probate With A Trust
First, consider probate avoidance, particularly if the property is located in a state other than the owner’s primary residence. The problem arises when the owner dies with title to the property in her name.
In addition to a probate proceeding in the owner’s state of residence, there will need to be an “ancillary probate” proceeding in the state of the second residence. A Big Hassle.
A fairly simple revocable trust, or living trust, could completely avoid the probate process in the second state. Before the “owners” death the trust owns the property. After the “owners” death, the trust continues as the record owner. Thus, no probate.
Use A Trust To Protect Property
Certain types of trusts can be created that protect the property for the family after the incapacity of the principal owner. If the trust is irrevocable and correctly designed, the property will not count for Medicaid purposes. Start early, however, because it’ll take five years to completely protect the home for Medicaid.
While in the trust, the property will also be immune from the liabilities of the children the owner may have originally been thinking of transferring the property to.
Trusts Are Tax Smart
Further, if the property is transferred directly to the children, the parent’s “tax basis” also transfers to the children. Tax basis is simply the floor value used for calculating the “profit” that someone will realize if they sell the property.
In the hands of the person who bought the property, tax basis will be what he paid for the property. In the hands of a person who inherited the property, basis will be whatever the property was worth when the person inherited the property. Importantly, in the hands of a person who received the property as a gift, basis will be the same as the basis of the person who made the gift.
What difference does this make? Say Jack’s basis in Palm Isle is $25,000 because that is what he paid for it or because that is what dad’s basis was when he gave it to Jack. Later Jack sells the property for $100,000. His “gain” or profit is $75,000. Uncle Sam and most states are keenly interested in gain, because they tax it!
On the other hand, if Jack put the property in a properly designed trust that provided his children would receive the property on Jack’s death, and on Jack’s death the property is worth $100,000, that will be the basis in the hands of the children. If they sell the property for $100,000 there will be no (as in zero) taxable gain. Not too shabby.
Wait, there’s more. If the property is Jack’s principal residence and the trust has been properly designed, the trust will qualify for the capital gains tax exclusion that would apply if Jack directly sold his residence. To use a South Carolina term, that is “elegantly shabby”.
Bob, what kinds of assets other than real property be put into a trust?
Bob Mason says
Just about anything you want except tax-qualified assets (like retirement plans or IRAs).
Great article. What about 2nd homes with a mortgage? Is a trust still a good idea?
Bob Mason says
Most mortgages have what is called a “due on sale” clause that could accelerate the loan if there is an actual or attempted transfer of the mortgaged property. HOWEVER, the Garn-St. Germain Act, a federal law from 1982, provides that a mortgage lender may NOT accelerate a loan if the secured property is moved to a trust (or residential unit) in which the owner is a beneficiary and under which the owner is the occupant of the property. A transfer of a second home to a trust naming the owner as beneficiary and in which the owner retyains a right to use the pr0perty should cause no problem.
Jerry Anderson says
Bob, we’re looking at redoing our wills and maybe incorporating a trust for the real property. We’re in Georgia and need to find a qualified attorney that can handle the writing at a reasonable fee. Do you have any suggestions?
Bob Mason says
Depends where you are, Jerry, and what you have going on. Why don’t you contact me off list at
ram “at” masonlawpc.com
Kevin L says
This may be a silly question, but in what state do you form the living trust; primary residence or state in which the vacation home is located?
Bob Mason says
That’s not a silly question at all. I usually form the trust under the law of the state in which my client is living (either North Carolina or Georgia . . . which, of course, are the states in which my clients will be living because those are the states in which I am licensed to practice law).
Ric Buckner says
Bob, what a wonderful (and entertaining) website! Thanks for providing it.
We (a group of six couples in NC) jointly own a condominium in SC under our own homemade “timeshare” arrangement. Each couple has the right to devise their interest as they choose. As the first spouses die, their interest will pass as entirety property, but, before many years we will be facing a string of SC ancillary estate administrations.
Can we jointly set up a Trust, convey the condo to it, and provide for our “interests” in the Trust to pass by our Wills in NC, for example being split among our children, like we could if we titled the unit in the name of a corporation and passed our shares under our NC Wills? (I had considered setting up a corporation, but the CPA felt we were creating an ongoing significant expense and also losing our stepped-up basis.) Or do we need six individual trusts?
And by the way, does the trust have to file annual tax returns or otherwise have ongoing liabilities?
Bob Mason says
The only problem with a single trust is it can become somewhat “clunky” with respect to 6 different couples determining the beneficial enjoyment of the property. The tax compliance aspects would be minimal or nonexistent if there wasn’t any income to report.
True, there are basis issues if you put it in a corporate entity, but is it that serious an issue spread among six couples? From an administrative standpoint an LLC (no reason why it couldn’t be an NC LLC) might be easier. There are no ancillary probate issues, tax compliance isn’t THAT dfficult. The LLC would have a manager (elected by the members?) and LLC membership interests could be devisable.
So . . . while I like trusts for closely/single family held properties, an LLC might be easier when dealing with six families. Just my two cents worth . . .
wanda Porter says
Should a person change from a revocable living trust to an ‘irrevocable’ when you think medicaid will likely not be a factor? Thank you in advance for your updates and valuable information.
bob mason says
If you are not at all concerned about Medicaid or other liabilities and asset protection concerns, this person is quite possibly just a well-off with a revocable trust. Irrevocable trusts take on much of their magic when asset protection planning of some sort is paramount.
Alley Keosheyan says
Dear Mr. Mason,
As a web content writer who has done many sites for law firms, I have to say that yours is the most engaging and informative sites of its kind I’ve ever come across. You are living proof that legalese doesn’t have to put people to sleep. Big time props to the author! If I lived in NC, I’d hire you in a heartbeat. Let me know if you ever get a wild hair and decide to move to Wyoming.
Take care and God bless.