Whether you are looking to own a vacation home for a couple of years or to keep it in the family for generations, the planning you do now can help you avoid challenges down the road. In this four-part series, we’ll discuss ownership structures, long-term estate planning, tax benefits, and tips to avoid disputes.

Part 3 – Estate and Income Tax Planning

In Part 1 of this series, we discussed structures through which a family can own a vacation home. In Part 2, we discussed how to plan for succession by the next generation. In this Part 3, we discuss taxes that should be considered in connection with that succession.

Most salient is the estate tax, sometimes called the death tax. Roughly speaking, it is a tax on the value of everything you own at death, other than assets going to charity or a surviving spouse, in excess of a specified threshold. Massachusetts imposes a state-level tax on assets transferred at death, in excess of $2M, at rates ranging from 7.2–16.0%. There are also Federal taxes on assets transferred either during life (gift tax) or at death (estate tax), in excess of $13.99M as of 2025—increasing to $15M in 2026 and thereafter with inflation—at a flat rate of 40.0%.

The estate-tax considerations involved in planning for a vacation home are generally no different from those involved in planning for other kinds of assets. What is different is that the home is held not merely for investment but also for personal use, and that it has a fixed location (unlike “intangible” property such as securities). Those differences can create additional tension between tax and non-tax goals and raise questions about when to transfer a vacation home to your heirs.

Transferring a Vacation Home Now

Transferring a vacation home during one’s life can be an effective way to reduce estate taxes and shift future appreciation out of the taxable estate. However, in order to be done successfully the donor must relinquish sufficient rights to and control over the home. It also means that the recipients will take the donor’s income-tax basis in the property, instead of potentially benefitting from the so-called step-up in basis at death.

Benefits

• Estate Tax Reduction: Transferring ownership during life removes the home from the Massachusetts taxable estate and removes any future appreciation from the Federal taxable estate.

• Gift-Tax Valuation Discounts: Fractional interests can be transferred at discounted values, lowering the Federal gift-tax charge. If appropriate, the gift-tax charge may be further reduced by transferring the home to a specialized vehicle called a “qualified personal residence trust” or QPRT.

• Gift-Tax Annual Exclusion: Unlike deathtime transfers, lifetime transfers are generally reduced by annual gift tax exclusions ($19,000 per recipient in 2025, increasing with inflation).

Considerations

• Loss of Step-Up in Basis: Recipients of a lifetime gift take the donor’s income-tax basis, meaning future sales could trigger significant capital gains. If the recipients are “grantor trusts,” however, the donor may later be able to swap in other assets of then-equal value in order to more efficiently use the step-up.

• Control and Use: The donor no longer owns and controls the home. Gifting to a trust and/or LLC, however, allows the donor to establish some enforceable terms, perhaps including the option to rent the property back for fair market value—which rent may be an additional tax-free transfer to the recipients.

Example: Donor transfers a $5M vacation home to an LLC and transfers minority interests in the LLC to multiple recipients. The aggregate value of those interests might be $3.5M for gift-tax purposes, after applying discounts. This translates to an immediate $0.6–0.7M estate tax savings, before taking into account the removal of future appreciation from the taxable estate.

Transferring a Vacation Home Later

Transferring a second home at death may maximize tax efficiency in some cases, particularly when the property has already appreciated significantly. The primary advantage lies in the step-up in basis.

Benefits

• Step-Up in Basis: Heirs receive the property at its fair market value at death, eliminating capital gains on prior appreciation. For example:

• Pre-death basis = $1M
• FMV at death = $5M
• Post-death basis = $5M → no income tax on $4M appreciation.

Considerations

• Estate Tax Inclusion: The entire fair market value is included in the taxable estate, potentially creating large estate tax liabilities. However, it may be possible to avoid state estate tax if the donor is not a resident of the vacation-home state and the home is held through an “intangible” structure such as an LLC.

• Liquidity Pressure on Heirs: Estate taxes are typically due within nine months of death. If heirs lack liquidity, they may be forced to sell the property to cover taxes. This issue should be monitored as part of planning and may be mitigated through the use of life insurance and other tools.

Whether the home is transferred during life or at death, utilizing a long-term trust as the owner of the home can often avoid subjecting the home to estate tax for successive generations of trust beneficiaries.

A second home can be a cherished asset and a valuable component of your wealth strategy—but without proactive tax planning, it can also create significant hidden costs.

Estate Planning for Vacation Home Series

In the next issue (Part 4), we will discuss tips for avoiding conflict when owing a vacation home.