Downsizing in a down market
Is this the year the kids buy you out?By Tom Kelly, Wednesday, February 18, 2009.
It's been a different winter than usual this year. Roofs have collapsed under the weight of our country's surprising snows. (A white dusting in Las Vegas? Really.) Violent flooding has moved foundations and deposited debris never seen before on lakeside lots and creekside properties.
The repair and maintenance on primary residences has been expensive for many. And, the thought of keeping a weekend getaway in a down economy can really hit home if the kids are grown and no longer around to do the heavy lifting.
Is this the year to ask the kids to buy you out, or to sell the mountain retreat outright -- suddenly a financial luxury/burden you no longer need -- and hunker down for another tight financial year?
Two attractive options for keeping the cabin in the family are an outright sale to the kids -- the parents could even rent back from the kids if they choose -- or placing the cabin in a Qualified Personal Residence Trust. Both can be beneficial depending upon the parents' need for cash and the children's ability to pay. Unlike the couple's personal residence, the cabin will not escape a capital gain tax. The place has probably appreciated in value so a tax is almost certain even though most of it may well be offset by capital improvements.
The actual gain is the difference between the adjusted sales price (selling price less selling expenses) and the adjusted basis. The adjusted basis is the original cost plus capital improvements. Capital improvements are the cost of improvements having a useful life of more than one year. Examples include the new roof, dock, deck, remodeled bathroom and finished basement.
Generally, an expense is a capital improvement if it adds value to the property or extends its useful life. If these criteria are not met and the expenditure is considered necessary to maintain current usefulness, it is a maintenance cost.
Under the Qualified Personal Residence Trust (the cabin can be viewed as a second residence), you place the cabin in a trust for a specific time period. You choose the term of the trust, for example 10 or 15 years. During that time, you continue to use it. If you survive the term, the cabin goes to the kids and your estate is reduced by the value of the cabin. If you die during the term of the trust, the cabin reverts back to your estate as if no trust were set up.
"I find a Qualified Personal Residence Trust works best for clients who need to reduce the size of their estate and have an heirloom-type property to pass along to the next generation," said Bob Pittman, an attorney specializing in trusts and senior issues. "The tricky and sometimes delicate-to-discuss part is guessing at a parent's life expectancy. The longer the term of the trust, the more you save in estate taxes. But, you get a big zero for your efforts if the parent dies too soon."
The government has statistical tables, based on age and life expectancy at the time the trust is made, on the value of their right to use the cabin.
The main drawback for children buying a family cabin is that a lot of kids can't afford to carry the negative cash flow each month. However, they are providing an income for the folks and could offset some losses by renting the cabin -- perhaps until the siblings' salaries rise. The sale also pulls the appreciation out of the parents' taxable estate now instead of later, and gives the kids more mortgage interest to deduct from their taxable income.
If the kids do convert the family getaway to rental property -- even temporarily -- the rules change significantly. If the kids switch to a rental status, they should do so for periods of at least one year at a time. They would receive all the tax benefits of rental property, including depreciation.
The way the individual families use the cabin could change, too. The Internal Revenue Service will not allow the children to show a taxable loss on the property if they personally use it for more than 14 days or 10 percent of the rental period. Personal use includes a rental to any relative unless you charge a fair-market rent.
Pittman said he often encourages families to write a "mission statement" for the family cabin. If a family works together on a mission statement, the chances of long-term success are much greater. Everyone in the family needs to feel they have contributed to and agreed on the elements of the mission statement. It then becomes something they will defend and pass along to succeeding generations, and the legacy of the parents is preserved.
If you have a family getaway and want it to stay in the family, you can sell it to the kids now, or create a trust for them so that future appreciation will avoid taxation. The first choice lets you supplement your income with monthly payments from the children, and the second sets up a larger nest egg for them. To decide on the best option for you, check with an accountant and tax attorney.
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