Safeguarding Your Family’s Second & Vacation Home

Key Takeaways:

• Vacation homes carry unique financial, legal and emotional considerations that can differ from primary residences.
• Family dynamics play a crucial role in long-term ownership and succession planning.
• Proper structuring—through trusts, LLCs, or other legal entities—may protect against liability, simplify estate transitions, and optimize tax benefits.
• Techniques for avoiding probate are essential for seamless property transfers.
• Thoughtful planning with your wealth advisors can ensure your vacation home remains a cherished family asset for generations.

In this article, we will describe four key points that should always be kept in mind regarding vacation homes and other non-homestead real estate. While this article is not intended as an exhaustive discussion of all possible factors and variables involved in estate planning for vacation homes, we aim to highlight several of the most common issues and some of the most popular solutions:

• Key Point 1: Liability Protection
• Key Point 2: Family Dynamics
• Key Point 3: Avoiding Ancillary Probate
• Key Point 4: Estate Tax Planning

For many families, the purchase of a vacation home represents a proud achievement and mark of success.

These vacation properties, ranches and other real estate holdings are typically some of the most emotionally meaningful and significant assets in a family’s portfolio. Vacation properties are places for the family to spend quality time together. They can easily have connections to some of life’s most significant life events —holidays to wedding celebrations, anniversaries and family reunions. Whether the property is a beach house, a ranch or a condominium at a ski resort, several common factors must be considered to ensure that real estate is properly integrated into a family’s wealth, estate and asset protection plans. A vacation home is a high-value asset —financially and emotionally. That’s why estate planning for second homes and vacation properties is a high priority for any family that owns one or more of them.

Key Point 1: Liability Protection

Real estate can be among the most prized of all assets. However, it also comes with potential liabilities, particularly when it comes to properties like vacation homes that may be rented out to third parties when the owners are not present. The concept of premises liability – perhaps most familiar in the form of “slip and fall” civil lawsuits – is crucial to recognize in this regard. It may lead to lawsuits against the owner of a property as a result of another party suffering an injury on that property. Ranches and other rural properties, where potentially dangerous activities such as hunting and the use of off-road vehicles, can be especially hazardous for their owners if proper precautions are not taken. Luckily for property owners, steps can be taken to reduce potential liability exposure. 

Real estate can be among the most prized of all assets. However, it also comes with potential liabilities, such as “slip and fall” civil lawsuits. Proper insurance coverage for a property is a key first line of defense.

Purchase a relevant and effective insurance policy

Proper insurance coverage for a property is a key first line of defense. It is important to note that insurance, unlike other methods of liability protection, has the benefit of legal defense costs potentially being paid by the insurance company rather than the owner. This benefit provides good reason to be certain all properties have proper insurance with appropriate coverage levels. Consult with an experienced insurance agent to ensure that all coverages are appropriate for a property.

Create and distribute properly drafted waivers and documentation

Carefully drafted liability waivers, releases and documentation can be a key form of protection for when third parties use or enter the owner’s property, particularly with regard to hunting activities and off-road vehicle use on ranches. Consult with an experienced attorney to assist with preparation of such vital property documents. 

Establish ownership in a limited liability company 

Limited liability companies (LLCs) are one of the most popular forms of ownership for non-homestead real estate, and they offer many relevant advantages. Placing a vacation home or ranch into a properly structured and maintained LLC may potentially reduce the owner’s exposure to liability. Establishing an LLC separates a business entity between the owner and the asset. Moreover, an LLC can potentially add a layer of privacy to the owner’s real estate holdings and can also frequently serve as a useful element of an estate plan. LLCs are typically preferred over corporations for entities to own real estate, due to their potential for the more flexible tax treatment of real estate held within. Always consult with your attorney and CPA on the appropriate structure for purchasing real estate.

It is worth noting that while LLCs are a popular tool for owning vacation homes and other nonhomestead real estate, they are frequently not suitable for owning a primary residence. In many states, LLCs do not qualify for certain favorable tax and/or asset protection benefits afforded to homestead real estate. For example, an LLC does not qualify under the highly-protective homestead laws and homestead property tax exemptions enacted in Texas.

Key Point 2: Family Dynamics 

Due to the special and often highly emotional and sentimental nature of vacation homes, ranches and other unique real estate holdings, these assets can be a source of tension among family members. That’s often the case when it comes to estate planning for vacation homes. For example, leaving a family ranch to just one child could cause hurt feelings. At the same time, dividing a property among multiple children or family members could create an unmanageable situation with multiple owners attempting to operate and use the property in pursuit of very different goals. Clarity around maintenance, management and use of the property is critical.

Careful planning and the use of structures such as the aforementioned LLCs, or family limited partnerships (FLPs), can play a key role in directing the operation and even the governance of a piece of property. They can be used to “keep the property in the family” and also maintain it in an efficient and orderly fashion. Entity structures can even be used to enhance family dynamics by providing a structure and a governing framework. Heirs can then work together to achieve positive results and goals for the property. Again, the potential challenges of family dynamics make it vital to properly integrate such properties into overall wealth and estate plans. 

Careful planning and the use of structures such as the LLCs, or family limited partnerships (FLPs), can play a key role in directing the operation and even the governance of a piece of property. They can be used to “keep the property in the family” and maintain it in an efficient and orderly fashion.

Key Point 3: Avoiding Ancillary Probate 

The decision to structure an estate plan to avoid probate is largely dependent on state of residence. For example, California has very costly and complicated probate, which most people wish to avoid. Probate avoidance may be less of a concern in a state such as Texas, where probate is relatively fast and uncomplicated. It comes as a surprise to many clients that, absent appropriate planning measures, probate will typically be required in any state where a decedent owned real estate in his or her own name, in addition to the probate required in the decedent’s home state. Thus, a decedent who lived in Texas but who also personally owned a ski chalet in Colorado and a beach house in Florida would require probate proceedings in all three of those states to clear title to all of those properties.

Such probate proceedings are known as “ancillary probates” and can quickly escalate both the expenses and level of complexity involved in probate. This is true even for a resident of a state like Texas, where probate is often typically less burdensome. Luckily, there are excellent techniques available to avoid the need for such ancillary probates. Such as, the use of revocable living trusts, which are often combined with LLCs or other entity structures and can be used to avoid such ancillary probate situations. Again, it is vitally important to consult with professional advisors to ensure that vacation properties are titled in the most appropriate and favorable manner.

Ancillary probates can quickly escalate both the expenses and level of complexity involved in probate. Luckily, there are excellent techniques available to avoid the need for such ancillary probates.

Key Point 4: Estate Tax Planning

Transferring a vacation home via a will or revocable living trust is a common practice. However, from an estate tax perspective, neither a will nor a revocable living trust provides any benefit, because the property remains inside the taxable estate of the owner. Instead of leaving the vacation home directly to heirs and gifting directly to heirs, consider these strategies which alleviate some of the risks identified in this article.

A Qualified Personal Residence Trust (QPRT) offers stronger estate tax planning opportunities. In a QRPT, the grantor transfers their interest in the real estate to the QPRT while retaining the right to use the property for a period of time. As a grantor trust, the tax-deductible expenses of the property remain deductible to the grantor during the term, and in some cases, even after the term. The grantor uses a portion of the property's fair market value, rather than the total fair market value, toward the lifetime gift exemption, based upon the retained usage of the home. However, if the grantor dies during the retained interest term, the entire value of the property is included in the grantor’s taxable estate. Should the grantor survive the term of the QPRT, the entire value of the asset is out of the estate and they will have to rent the property from the remainder beneficiary or beneficiaries. Renting the home from the beneficiaries can be a wonderful way to provide funds for ongoing maintenance and repairs. Thus, a properly structured QPRT can serve to remove the value of a vacation home from the grantor’s taxable estate, while also using a smaller portion of the grantor’s gift tax exemption than would be used as an outright gift.

Structures such as Family Limited Partnerships or LLCs (FLPs) can also play a key role in estate tax planning for a vacation home. Often, clients will use such a structure to make gifts in an orderly fashion, while also obtaining valuation discounts through the use of such entity structures. Again, this serves to leverage the value of a client’s lifetime exemption amount by reducing the value of gifts made. Another option is a gift of the property to an irrevocable trust during lifetime. In fact, the property could be first placed in a FLP and then the FLP interests gifted into the irrevocable trust. The advantages of this strategy include management of the property by a Trustee according to the terms of the trust, multi-generational estate planning, clear definition of rights of beneficiaries and possibly income tax benefits. 

One important item to note is that techniques, such as the QPRT, irrevocable trust or the use of FLP structures, to transfer a piece of real estate out of a grantor’s estate come at an expense. They sacrifice the so-called “step-up” in tax basis that may be obtained under current tax law for property that was part of a decedent’s taxable estate at death. Because the step-up in basis can potentially save heirs significant amounts of capital gains taxes, it is very important to carefully consider and discuss the tax planning aspects of any of the aforementioned techniques with a planning team, attorneys and CPAs. It is crucial to ensure that income tax benefits are not being unnecessarily sacrificed as part of an estate tax planning strategy. 

Conclusion 

Vacation homes, ranches and other unique pieces of real estate are often regarded as the crown jewel of a family’s portfolio of assets. While they can be a source of great enjoyment and shared family experiences, they can also offer challenges for wealth, estate and asset protection plans. Due to the special nature of these assets, it is vital that proper wealth, tax and estate planning for vacation homes accompanies the acquisition, management and sale of such properties. Discover more tips and strategies to navigate vacation homes and non-homestead properties by contacting your Comerica Relationship Manager or request to speak to a Comerica professional.

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Follow our author on LinkedIn: Lisa Featherngill, National Director Wealth Planning