Your Vermont Vacation Home and Estate Planning
Posted on Oct 22, 2013
We recently met with a new estate planning client who is not a native Vermonter, but a West-coast transplant. This client felt compelled to meet with us after he had read somewhere that Vermont was “not a good place to die owning real property”. Although we were not able to verify the author of such a statement, we sympathized with the client’s concerns. Indeed, generally Vermont’s probate administration process requires full administration of estates above a rather small value ($10,000). Requiring full administration seems particularly inappropriate when the only asset to probate is the vacation home of an out-of-state resident.
Here is how the process works. When the out-of-state owner of Vermont real property dies, the executor of the deceased’s estate will be required to open an ancillary probate proceeding in the Vermont Probate Court District where the property is located. Without opening a Vermont probate proceeding, title to the property cannot be transferred from the decedent to the decedent’s takers under his/her testament or to the decedent’s heirs at law if no testament exists. In a Vermont ancillary probate proceeding, the probate court must approve the inventory, confirm the payment of debts, document payment of taxes, funeral expenses, costs of a monument (and payment for perpetual care), and approve the final decree of distribution. With all the hassles of getting signatures, proving the Will (Vermont does not have a self-proving statute), and attending to all related formalities, the time period between death and the distribution of the property out of the estate could be nine to eighteen months and could cost hundreds of dollars in court fees and thousands of dollars in legal fees.
We understand that states that have adopted the Uniform Probate Code (UPC) tend to permit unsupervised administration through a non-judicial registrar unless the dollar amount is high or a party or creditor requests supervised administration. In other states where we have referred and followed probate matters, we have noticed that informal administration streamlines the probate process and frequently avoids appearances before a judge.
Whether probate administration is streamlined or not, the fiduciary for a decedent who died owning Vermont real property must file a Vermont income tax return if the primary estate had to file a federal income tax return and either (1) earned or received more than $100 in income from Vermont assets or (2) received more than $1,000 in gross income from all assets of the estate. In addition, if the primary estate is required to file a federal estate tax return, a Vermont estate tax return must be filed reporting estate tax on the Vermont-sited property. Before the Vermont probate can be closed, the probate courts must receive a tax clearance issued by the Vermont Department of Taxes for these filings.
Whatever burdens the Vermont probate process imposes on the executor or administrator of an ancillary probate, the fact is that the probate process can be avoided with some advanced planning. In our experience, the following are the techniques that many out-of-state real property owners use to facilitate the transfer of their Vermont real property at death.
- Transfer into Lifetime Revocable Trust. – If the out-of-state property owner already has established a trust that is valid under a state law other than Vermont, we recommend that it be reviewed to see if it is adequate to transfer any Vermont real property owned by the Settlor of the out-of-state trust. If a trust agreement does not already exist, the out-of-state Vermont property owner could consider contacting a Vermont trust and estate lawyer to have one prepared. Most Vermont trust and estate attorneys have a drafting starting point for a trust agreement that can be adapted to the client’s needs. The deed transferring the real property into a revocable trust created by the owner is a tax-free transfer for income tax purposes, Vermont Property Transfer Tax (PTR) purposes, and for Vermont land gains tax purposes. Moreover, we understand that federal law specifies that the transfer to such a trust does not accelerate any mortgage indebtedness on residential property pursuant to a due on transfer clause in the mortgage.
- Limited Liability Company (LLC).– Frequently, we advocate the use of LLCs so that a Vermont probate is not necessary to transfer the Vermont real property to the property owner’s intended beneficiaries. Upon the death of the owner of an LLC interest, we take the position that an appropriately drafted LLC operating agreement can allow what we term a “designation of beneficiary” document to indicate who will receive the decedent’s LLC interests. According to Vermont business law, an LLC interest is considered as intangible personal property, and the LLC agreement is a contract among the parties to the agreement. Before an out-of-state property owner uses an LLC for probate avoidance purposes, we recommend that the client understand the potential Vermont income tax, PTR, and Vermont land gains tax implications of the particular arrangement. The federal income and estate and gift tax aspects can be communicated by the non-resident property owner’s own tax return preparer or accountant if he or she has engaged such a professional.
In our experience, LLCs are particularly useful for non-US-tax residents. As we pointed out, under Vermont law an LLC interest is intangible personal property, and federal estate tax laws specify that the intangible personal property of a nonresident alien is not subject to federal estate tax. Perhaps the IRS might find use of an LLC to hold otherwise taxable real estate as a transparent conduit for purposes of its estate tax, but when we last checked the law on this topic, the IRS had not yet done so in a regulation or in a public ruling. To be safe, we advocate a diffusion of nonresident ownership in the LLC so that no nonresident individual owns a taxable value of Vermont real property. In general, unless a tax treaty applies between the US and the foreign jurisdiction of the Vermont real property owner, the federal estate tax exemption is only $60,000.
- Foreign Corporation. - For a non-resident alien who plans on acquiring Vermont real property, his or her counsel might advocate the use of a foreign corporation as owner of the Vermont real property. If a foreign corporation is the direct owner of the Vermont real property, under federal tax law the non-resident alien will own only the stock of the foreign corporation and not the underlying real property. Federal tax law does not impose its estate tax on stock in a foreign corporation held by a non-resident alien at death. The use of corporations in offshore banking centers can assure that the identity of the individual indirectly owning Vermont real property will be difficult to ascertain with any facility. Here again, we recommend that the foreign Vermont property owner take tax advice on the advantages and disadvantages of this structure.
- Enhanced Life Estates. – Deeds creating an enhanced life estate in the occupier of the Vermont real property with a remainder to the life estate owner’s children can be used to avoid probate while ensuring that real property is transferred immediately by operation of law at the death of the life tenant. The life estate is “enhanced” in that the life tenant is permitted by deed to sell the property and keep all of the proceeds. Although principally used for Medicaid asset planning, such conveyances are becoming more frequent as a probate avoidance device. Our firm web site (www.fgmvt.com) contains an article on this topic (“Tax and Medicaid Aspects of the Standard Vermont Estate Plan”), which compares this device favorably to the use of a joint tenancy with right of survivorship.
- Joint Tenancies.- When the Vermont property owner is married, the property can pass to the surviving spouse if the property is held by the spouses as tenants by the entireties. A joint tenancy with right of survivorship can be used to pass real property by a survivorship feature by non-spouses. Rather than discuss the advantages and disadvantages of using this form of ownership to pass Vermont real property at death, we recommend that interested individuals review our article on this topic mentioned above.
- Personal Residence Trusts (PRTs).– A personal residence trust is a creation of the federal gift and estate tax laws. It offers the owner an opportunity to transfer an interest in real property with a reduced gift and estate tax charge. Like enhanced life estates, PRTs allow for probate avoidance, but they also can provide significant gift and estate tax planning advantages. Such an arrangement should be considered by individuals who have wealth that make them subject to the federal (and hence Vermont) estate tax.
The Vermont legislature is currently in the process of reforming its probate statutes, a process that is long overdue. Vermont’s statute on wills is based on England’s Wills Statute of 1847. Vermont’s current laws on the spousal share in intestacy originated in England’s 1670 Law of Descent. The legislature tried to amend the laws of descent last year, but the Governor vetoed the legislation because it contained a technical error. It does not appear that any reform, regardless of how Vermont estate legislation fares in the Winter and Spring 2009 legislature, will have a great effect on the administration of ancillary probate estates. Therefore, it would behoove an out of state owner of real property in Vermont to consider using one of the ownership structures discussed in this article. Such measures will best preserve the Vermont property owner’s real property after death and ensure that such individual’s heirs will find Vermont to be “a good place to die and own property.”