When second-home owners give away or bequeath their property to their descendants, the tax consequences can be significant, but taking the right estate planning moves now can reduce and in some cases even eliminate that tax burden.
For large estates, there is greater urgency to make plans and create trusts because the elevated federal estate tax exemption authorized in the Tax Cuts and Jobs Act of 2017 is set to expire. That federal law doubled the exemption — but only through the end of 2025.
And for second-home owners whose net worth does not exceed the federal or state estate tax threshold, there are still smart estate planning steps to take before passing on a vacation home.
Attorney Greg Matalon, a partner with Capell Barnett Matalon & Schoenfeld who concentrates in estate planning, shares his advice for second-home owners who want to keep their Hamptons home in the family.
It starts with understanding the federal estate and gift tax exemption as well as New York State’s estate tax exemption, and the differences between them.
In 2022, the federal estate and gift tax lifetime exemption is $12.06 million per person, and that amount is adjusted for inflation annually. Gifts and transfers between spouses generally are not subject to gift tax or estate tax, and the combined lifetime exemption a married couple can use is $24.12 million.
Matalon explained that means that he could give a $12 million house to another person he is not married to, an act that would use up all of his gift and estate tax exemption, and — assuming he died penniless — there would be no federal tax on his estate.
The way the law currently stands, if he waited a few years to give the house away and the doubled exemption expired as scheduled, he would be subject to gift tax on half the home’s value.
Matalon stressed that it is important to make gifts early, while enlarged estate and gift exemptions are still in play — before the provision in the Tax Cuts and Jobs Act that doubled the exemption sunsets in January 2026.
“What does that mean for the taxpayer? That means that the exemptions for gift and estate and generation-skipping transfer tax will be reduced by one half,” Matalon said.
And while it’s possible Congress and the president could agree to extend the doubled exemption rather than let it expire and revert to the old rate, there is no guarantee that will happen.
Fortunately for those planning their estates now, gifts and trusts that were made prior to the expiration can still benefit from the doubled lifetime exemption.
There’s also New York State estate tax to consider, with an exemption of $6.11 million, though New York treats gifts differently. “If I make a gift and die within three years, for New York State purposes, that gift is included in my estate,” Matalon said. “New York does not have its own gift tax. But if I make the gift and die more than three years later, that gift is not part of my taxable estate.”
The three-year rule changes the calculus of estate planning for New York State residents.
“A lot of my clients, they want to make their gifts for New York State estate tax purposes early because they know they’re going to live for three years,” Matalon said. “So they have a clean and full exemption for estate tax when they die.”
To take advantage of the doubled federal exemption while it’s still available to them, second-homeowners can put the property into a trust.
“We’re doing this for a lot of our clients,” Matalon said. “We’re creating credit shelter trusts, either in their will or during their lifetime. During their lifetime, they’re often called SLATs: spousal lifetime access trusts.”
He said a Hamptons house could be placed into a SLAT, and the receiving spouse can live in it and collect all of the rental income that the house generates. The giving spouse can live in that house as long as the couple remains married.
“It’s not a panacea, but it’s a great way to use the enhanced exemptions right now,” he said.
Another option is a credit shelter trust. It is a trust formed in accordance with a will after one spouse dies, and it is a way to “soak up” the estate tax exemption of that spouse, Matalon explained. Instead of an asset going directly to the surviving spouse, it goes into the trust and is not considered part of the surviving spouse’s own estate.
Matalon says many clients keep the size of the credit shelter trust under the $6.11 million New York State exemption in order to avoid triggering the state estate tax. Then when the surviving spouse eventually dies, the asset may be passed down free of estate tax to subsequent beneficiaries.
“You can take that house for $6 million, put it in the credit shelter trust, and it’s a way for the kids to get that without paying estate tax,” Matalon said.
If that $6 million house inside the credit shelter trust appreciates to $10 million by the time the second spouse dies, that additional $4 million in value is not subject to estate tax.
A married couple with a net worth over $12 million or a single person with a net worth over $6 million needs to be thinking about this stuff, according to Matalon.
“They have to be thinking about planning their estates to minimize estate tax,” he said. “But it’s more than that, I mean, there’s an estate tax part of it as well, but there’s also the beneficiaries. Let’s say one kid lives in Manhattan. The other kid lives in California. Does the kid in California want the darn house in the Hamptons? No. The kid in Manhattan wants a darn house in the Hamptons. The kid in maybe California wants some other asset. So planning for your kids to get the right assets is important in your estate plans as well.”
For families with net worths that are under the threshold for gift and estate tax, there are still tax considerations when giving a house to a family member.
If a house is gifted during the life of a parent to a child, the child will be responsible for more taxes when the house is eventually sold. But if a house is left to the child in the parent’s will, the child benefits from a step up in basis.
The basis is typically purchase price, plus the cost of capital improvements — less depreciation, if any. So if a second-home owner paid $1 million to purchase the house at fair market value, the basis is $1 million. If the owner later sells the house for $2 million, the difference between the basis and the sales price — $1 million — will be subject to capital gains tax.
But if the house appreciated to $2 million and the owner’s child inherits it, the new basis is $2 million. That’s a $1 million step up in basis, and that means if the child sells it for $2 million, there will be no capital gains tax.
Matalon explains this is why leaving a house to a child in a will is more tax advantageous than the parents giving the house away during their lifetime.
“If you gift this to somebody, the person you gift the home to gets carryover basis, meaning that person receives the same basis that you had in the property,” he said. “You pay a million dollars for it. You didn’t do any capital improvements. You sell it for $2 million — assuming no broker, no transfer tax — there’s a $1 million capital gain on which taxes are paid.”
Right now, there is no cap on step up in basis, Matalon pointed out, though he added that the law could change.
“There was a proposal on the table to get rid of step up in basis,” he said. Even a $100 million estate benefits from a step up in basis when inherited, and “there was going to be limits put in place to avoid this because it’s a huge capital gain win to people.”
He said he can’t predict whether the step up in basis will continue to exist.
Another estate planning tool he likes is called a Qualified Personal Residence Trust, or QPRT.
“That’s a great way to transfer real estate — either your primary or vacation home,” he said.
It works by putting a house into a trust for a set term. The longer that the house stays in the trust, the older that the donor is and the higher that interest rates are, the lower its value as far as the federal gift and estate tax exemption is concerned.
“As interest rates are going up, QPRTs become more attractive,” Matalon said. “So this is a really timely planning technique.”
Upon the expiration of the trust, the value goes to the owner’s kids.
“If I outlive the trust term, great. My kids get it, at a reduced use of my exemption,” Matalon said. “But I still want to live there because I love the Southampton area. I now have to pay rent to live there.”
The cost of rent must be equal to fair market value in order for the house to be considered outside of the estate.
“I’ve done it for clients, and it’s very effective at getting the house out of the estate at a reduced value,” he said.