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Estate Planning and Your Second Home: What Should You Know?

Many people dream of owning a cabin or a sunny beach house away from their homes. While these dreams are beautiful, buying a second home isn’t as simple as picking a new getaway. Your second home can increase your tax burden more than your first. There are also unique tax implications to keep in mind. According to Central Trust, understanding the strings attached to a second home is a must.

Will You Pay More Property Tax and Mortgage Interest?

If you already own one home, purchasing a second means doubling up on property tax bills. Your deductions for state and local taxes are also capped at $10,000. State taxes on your primary home often reach that limit on their own. As a result, a second home may increase your tax liability much more than you’d expect. While you can deduct mortgage payments on your second home, it’s limited to a combined total of $750,000 for both residences.

Does Renting Affect Your Taxes?

There are tax benefits if you plan to rent and limit personal use to 14 days or 10% of rental days. Doing so allows you to deduct utilities, maintenance and improvement costs as you would for any other rental property. However, be careful – renting to relatives at market rate still counts as personal use.

What About Capital Gains Tax?

When selling your primary residence, you can usually exclude a portion of the gains from taxes. However, this isn’t the case with a second home. Your vacation house is taxed as an investment property, which means capital gains can go up to 23.8%.

However, there’s a way to avoid paying capital gains tax on your second home. You may avoid capital gains tax if you live in it as your primary residence for at least two of the five years before you sell. Considering the average home price in America today, a lower tax rate can amount to impressive savings.

On the other hand, lost rental revenue or an increased cost of living could detract from these savings. Weigh the costs and benefits before choosing your tax management strategy.

How Important Is Record Keeping?

Maintaining solid records is crucial if you’re renting out a second home. If the IRS audits your return and you can’t provide evidence, you could face extra taxes and penalties. Keep receipts, bills and documents detailing any expenses related to the property. If you plan to avoid capital gains tax by living in the home, keep proof of your residence and travel during the time in question.

Be Real-Estate Smart with Our Help

The thrill of buying a second home should not overshadow the importance of thorough estate planning. Consult a tax professional or financial advisor to avoid costly mistakes.

Our law firm is dedicated to helping you plan your estate and minimize taxes, especially when second homes are involved. Schedule a consultation with us today to build a strategy tailored to you.

Key Takeaways

  • Double the Taxes: Owning a second home brings a second set of property tax and mortgage interest bills.
  • Rental Benefits: Renting out your vacation home could offer tax deductions.
  • Capital Gains Tax: Selling a second home could subject you to up to 23.8% capital gains tax. Living there for two of five years before selling can help avoid this.
  • Record Keeping is Essential: Proper documentation of expenses and rental income is crucial to avoid penalties in case of an IRS audit.
  • Consult an Advisor: Seek guidance from tax or estate planning professionals to create a sound plan and minimize tax implications.

Reference: Centraltrust (March 2024) “Second Homes & Tax Implications – Central Trust Company”

Why You Should Put Your House in a Trust

Putting a home into a trust has several benefits, from avoiding the lengthy probate process to providing potential tax advantages. This article discusses some of the intricacies of trusts and the importance of consulting with an experienced estate planning attorney.

What Is a Trust and Why Is It Important?

A trust is a legal arrangement where one person (the grantor) transfers ownership of their assets, like a house, to a trustee. The trustee holds and manages these assets on behalf of the named beneficiaries. One main benefit of putting property in a trust is to avoid probate, which can be a time-consuming and expensive legal process. The trust allows assets to be transferred to beneficiaries without the intervention of a probate court.

What Role Does the Trustee Have?

With a revocable living trust, you, as the original homeowner, will usually name yourself as the trustee, so you have control of the trust and the property. However, the original owner can name someone else as the trustee. This can be helpful in case the original owner dies and the real estate is distributed to the grantor’s beneficiaries according to the terms of the trust agreement. The trustee manages the property for the benefit of the grantor and any named beneficiaries of the grantor’s estate.

Benefits of Putting Your Home in a Trust

Avoiding the Cost and Time of Probate

By transferring ownership of your home into a trust, you can ensure that it passes directly to your chosen beneficiaries upon your death without the need to go through probate. Probate costs are borne by the estate and, thus, the beneficiaries. Probate also takes time, and while probate is in process, homes need maintenance, taxes need to be paid and costs add up. If the house is sitting empty, it can become a target for thieves and property scammers. If the trust is an irrevocable trust, it can also help protect assets from potential creditors and may even provide estate tax advantages.

Keeping the Transfer of the Home Private

If the house goes through probate, the transfer of property becomes part of the court and public record, and anyone will be able to see who inherited the home. When family dynamics are complicated, this can create long-lasting family battles.

Making the Process Simpler for Your Executor

If you have multiple real properties or homes in different states, the properties would be subject to the probate process in the state where located. Thus, if you have a vacation home in Arizona but live in Michigan, your executor will have to navigate probate in both states.

Revocable Trust vs. Irrevocable Trust: Which One Is Right for You?

There are primarily two types of trusts: revocable and irrevocable. A revocable trust, often called a revocable living trust or a living trust, can be altered or revoked entirely by the grantor while they’re alive. It allows homeowners the flexibility to make changes to the trust terms or named beneficiaries. A revocable trust lets a grantor control the property and make changes to the trust during their lifetime. The grantor retains the right to modify or dissolve the trust. The grantor can act as a trustee, manage the property, or appoint someone else. Upon the grantor’s death, the revocable trust becomes irrevocable, meaning no further changes can be made.

On the other hand, an irrevocable trust, once established, cannot be easily altered or terminated. Assets in an irrevocable trust are considered outside of the grantor’s estate, providing protection against creditors and potential tax advantages.

Working with an Estate Planning Attorney to Set Up Your Trust

Creating a trust starts when you engage an experienced estate planning attorney to help you decide the type of trust that best suits your needs for protecting your real and other property. It is essential to work closely with your attorney to complete each step so the home ownership is properly transferred to the trust.

  • Make a list of possible beneficiaries and trustees who you will include in the trust and gather their contact information.
  • Work with the estate planning attorney to transfer the title of your property to the trust. This involves drawing up a new property deed that names the trust as the property owner and getting it notarized in front of a notary public.
  • Record the deed and title to the property with the office that holds local property records.
  • Regularly review and update the trust, especially after major life events, to ensure that it remains aligned with your wishes.

The Role of an Estate Planning Attorney in Putting Your Home in a Trust

Working with an experienced estate planning attorney is essential when setting up a trust. They can provide guidance on the most suitable type of trust for your situation and ensure that all legal formalities are correctly observed. An attorney can help draft the trust document, ensuring that it aligns with state laws, and provide advice on transferring assets into the trust. Moreover, they can act as a valuable resource for questions or concerns, ensuring that the trust serves its intended purpose effectively.

In Conclusion

Putting your house into a trust is a strategic move for estate planning and avoiding probate. Furthermore, if the trust is irrevocable, it may help protect assets from potential creditors and provide estate tax advantages. Whether you opt for a revocable or irrevocable trust, it’s imperative to consult with an experienced estate planning attorney to ensure that your assets, wishes and beneficiaries are well-protected. Remember, a well-structured trust is more than just a legal document; it’s a legacy planning tool.

Why Would I Put My Home in a Trust?

Putting property in a trust can make managing and distributing your assets — including your home — easier after your death. It can also have legal and tax benefits.

Bankrate’s recent article entitled, “How, and why, to put your home in a trust,” says that a real estate trust is a legal arrangement in which the owner of a home, known as the “grantor” or “settlor,” transfers ownership of the property to another entity or individual, known as the “trustee.” The trustee manages the property for the benefit of the grantor and any named beneficiaries of the grantor’s estate.

You can place your home into a trust by signing a deed that names the trustee as the property’s new owner. The deed must be recorded with the local county recording office, and then the trust is the legal owner of the property.

The home’s original owner will usually name him- or herself as the trustee, so they can maintain control of the property. However, the original owner can name someone else as the trustee. This can be helpful in case the original owner passes away. Trustees are frequently adult children of the homeowner, who will inherit the property upon the homeowner’s death.

Trusts are often used for tax, estate planning, or asset protection purposes, as — depending on the type of trust — the property can be protected from creditors and transferred directly to the beneficiaries without going through probate. Two primary types of trusts pertain to real estate: revocable and irrevocable.

Also called a living trust, a revocable trust can be changed or dissolved at any time by the grantor (creator) of the trust. A revocable trust lets a grantor control the property and make changes to the trust during their lifetime. The grantor retains the right to modify or dissolve the trust. The grantor can act as a trustee, manage the property, or appoint someone else.

A revocable/living trust states the original homeowner’s wishes upon death. When the grantor passes away, the property in the revocable trust is distributed to the grantor’s beneficiaries according to the terms of the trust agreement.

An irrevocable trust, as the name implies, is more permanent and can’t be terminated or modified by the grantor after it’s been created, unless the beneficiaries agree to the change.

Reference: Bankrate (February 21, 2023) “How, and why, to put your home in a trust”

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