Estate Planning Considerations When You Own a Vacation Rental Property

Estate Planning Considerations

A vacation rental property is a substantial asset for anyone’s estate. And like all assets, care must be taken when planning when the owner(s) passes away or becomes incapacitated due to illness or other medical conditions.

NOTE: If you do own a vacation rental property and are concerned about the disposition of your property in the event you become deceased or incapacitated, PLEASE seek out advice from a locally licensed estate planning attorney and CPA to aid you in your formal legal estate planning.

This paper will not discuss federal or state estate tax ramifications. If your estate is big enough, it may be subject to additional taxation – please consult with your CPA/Financial Planner for details.
 

So let’s look FIRST as to what happens to your vacation rental property when you die. 

Before we do a deep dive, let’s do a quick worse-case summary.

If you individually own a vacation rental property and die without an estate plan, will, or trust, your heirs are in for a long and expensive process of determining ownership and property disposition at your death. It may not play out like you want or imagine, so planning is imperative.

OR...

If you become incapacitated due to illness or injury and DO NOT have a Durable Family Power of Attorney or similar document that legally names a person as your representative or “attorney in fact” in the event this level of incapacitation occurs, NO ONE can legally act on your behalf in the management of your vacation rental property until a judge/court names a custodian/guardian for you or names a conservator for the property. This can take a long time, and attorneys are usually involved - especially if there is more than one person who believes THEY should be in control of your assets. So again, planning is absolutely imperative!

So let’s start with the basics. The single most important consideration when answering this question is, “How is the property titled?”

Most vacation rental properties are owned:

  • Individually
  • Joint with a spouse or other person
  • In a business entity like an LLC or partnership
  • In a retirement account like a self-directed IRA or “Sole” 401(k)

This paper won’t dive into more sophisticated estate planning techniques like Family Limited Partnerships (FLPs) or similar advanced planning tools. If you have a very large or complicated estate, please seek out an experienced estate planning attorney in your area for help.

Let’s dive in to look at what happens under each scenario…
 

Individually and Personally Owned Property (one or more)

If you are an individual and personal owner of a vacation rental property, it’s no different than owning any type of “real property.” If you become deceased while owning a vacation rental property, the following can happen.

You don’t have a will or trust. 
When a person dies without a will, it’s called dying “intestate.” There are A LOT of people out there without wills! When there is no will to name an executor, state law provides a list of people who are eligible to fill the role. If a probate court proceeding is necessary (and if you own real property this is likely), the court will choose someone based on that priority list. Most states make the surviving spouse or registered domestic partner, if any, the first choice. Adult children are usually next on the list, followed by other family members. That person will then be charged by the court to inventory all estate assets and liabilities and submits to the court. The court will then determine who gets what – AFTER all estate debts are settled.

Every state has laws that direct what happens to property when someone dies without a valid will and the property was not left in some other way (such as in a living trust). Generally, only spouses, registered domestic partners, and blood relatives inherit under intestate succession laws; unmarried partners, friends, and charities get nothing. If the deceased person was married, the surviving spouse usually gets the largest share. If there are no children, the surviving spouse often receives all the property. More distant relatives inherit only if there is no surviving spouse and if there are no children. In the rare event that no relatives can be found, the state takes the assets.

Bottom line, this is a time consuming and potentially expensive way to settle an estate. If you do own a vacation rental property, the property is placed in an estate account, all income and expenses are administered by the estate’s court appointed executor, and NO net income can be distributed to anyone until the estate is settled and the property re-titled in the property recipient’s name.

You DO have a will. 
Ok, that’s better. Every valid will has a named executor (or executrix). That person has been charged by the decedent (at the time of their death) to inventory all estate assets and liabilities, and submits that list to the court. Again, if you own real property, your estate will probably have to be probated – even small estates have some level of administrative probate. So the executor will file the will, inventory, and liabilities to the court. The court will probably accept the plan as is, and the executor then pays debts and liquidates the estate.

Again, the income and expenses the vacation rental property creates is held in an estate account and is administered by the executor. No net income can be distributed except to the named owner of the asset once the estate has been settled and property re-titled.

You have a trust and the property has been transferred to that trust.
There are many different kinds of trusts, but we’ll focus on the most common when it comes to vacation rental property, the Revocable Living Trust (RLT).

People form RLTs for many different reasons.

Privacy 
When settling your will and probate, proceedings are public. Anyone can go to the probate courthouse, see who died, and see what assets they had and who got those assets. With a trust, the trust “corpus” (or what’s been transferred to the trust) is PRIVATE.
 

One-time Asset Liquidation and Distribution 

A trust can have many layers, conditions, and restrictions for the trust assets to be distributed…for multiple generations or even longer.

If you want to have your vacation rental property in a trust, find an experienced estate planning attorney – they can help you with trust creation, trust terms, and the re-titling and transferring of the assets (property) to the trust.

If you choose to do a revocable trust, you may have the power to reverse everything and move assets out if you wish – unlike an Irrevocable Trust that once it’s funded cannot be unfunded!
 

Jointly Owned Property (whether you have one or several)

There are 2 generally accepted and common ways to jointly title a property:

  • Joint Tenancy with Right of Survivorship (JTWROS)
  • Tenancy by the Entirety (TE)

They are practically identical and allow for the unlimited transfer of the asset from the deceased spouse to the survivor without fees or taxes, but depending on the exact circumstance and state, the surviving spouse may have to re-deed the property in their name alone.

So nothing more needs to be done for the property EXCEPT the surviving spouse must have a will, trust, or other estate planning document to ensure timely and inexpensive transfer of that property AFTER their death (see above).
 

In a business entity like an LLC or partnership

Because of the litigious nature of our society, having a Limited Liability Company (LLC) own your vacation rental property may be a wise move, especially if you have other assets you wish to insulate and protect in the event of a liability lawsuit. A lesser form of vacation rental property ownership in a business entity is in a partnership or subchapter S or C corp.

All of these entities have one thing in common – ALL of them have formal establishment documents and ALL have provisions in the event of a members/owners incapacitation or death…in those cases, corp. documents dictate the liquidation and administration of the asset.
 

In a retirement account like a self-directed IRA or Sole 401(k)

ALL qualified retirement plans (IRA, 401(k), SEP, CODA-SEP, 403(b), etc.) allow for a direct beneficiary to be named in the event of the death of the owner. All plans also have very formal plan documents and plan agreements which dictate what happens to the plan proceeds (vacation rental property) at death.

However, it’s not advisable to name a trust as your retirement plan’s beneficiary. It can cause tremendous mess and expense to do a tax favored final disposition and settlement.
 

Owner Incapacitation Due to Illness or Injury

No one wants to believe they will ever become incapacitated due to an illness or injury. We all think we’ll always be in control, so the thought of needing a plan that allows someone to act on our behalf and will never need to relinquish control until we decide to do it never crosses our mind.

Unfortunately, things happen. When they do, you (and your family) need to be prepared. So where do you start? The answer is both easy and inexpensive!

You need to draft and execute a “Durable Family Power of Attorney” (DFPOA). These are wonderful and flexible documents because YOU, while you are fine and taking care of your business, can determine what your DFPOA is allowed to do. You can make it as broad or as narrow as you want. You can name different people to be able to handle different aspects of your personal business. It, along with having a will, are the foundations of a good estate plan!

In a nutshell, when you have one of these in place and subsequently become incapacitated requiring your POA to take over for you, they can do for you - whatever you could previously do  for yourself – or at least all those things the DFPOA will allow you to do. All you have to do is list these things you want your POA to be able to do, and as far as vacation rental properties, you would want them to be able to direct and pay for repairs, coordinate special projects, execute management agreements, or even sell the property for you.

If you individually own a vacation rental property, you NEED one of these, or else there will in all likelihood be an expensive legal fight for control and the person you wanted to be in control might not be the one the court chooses. Worse, while this fight is going on, the management and maintenance of the cabin could come to a complete stop - and that’s just not the right way to go!
 

So, where do you start?

Our opinion? Seek out a competent, experienced and licensed attorney in your state and begin the process. Tell them you need at a bare minimum a WILL and a DURABLE FAMILY POWER OF ATTORNEY. And if you don’t have one, we suggest having a Living Will (also known as Advanced Medical Directives) drawn up too!

Follow the attorney’s direction for document storage and make sure to hold a family meeting to share this information so that EVERYONE knows what YOU want to do.

Also, it’s good to review these documents at least annually, especially if you have a significant life event like a divorce, death, or other major family change!

Hope this helps you and your family deal with some potentially difficult situations!

Have more questions? Speak with your attorney or give our Director of Business Development, Kevin Vozar a call at 615-517-8354 or email him at [email protected]u.com