Many family traditions include gatherings at vacation homes. However, leaving these properties to the next generation is not always in the best interest of the family. Some people try to make a simple solution work for a complex problem, leading to more challenges, as explained in the article “Succession planning for the family lakehouse” from NH Business Review.
Potential Problems
Joint ownership among siblings can lead to disputes about how the home is used, operated and maintained. Some children want to continue using the house, while others may see it as an income stream for a rental property. There may be siblings who cannot afford to participate in the house’s upkeep and need the cash more than the tradition. When joint ownership is presented as a surprise in a will, the adult children may find themselves fighting about the vacation home, with no parent around to tell them to knock it off.
Making matters more complicated, if the siblings live in different states and the house is in a neighboring state, ownership of the real estate at death may subject the decedent’s estate to estate taxes where the property is located. As a result, the property may need to go through probate in an additional state. Every state has its own tax rules, so the transfer of joint property will have to be analyzed by an experienced estate planning attorney knowledgeable about the laws in each state involved.
Legal Solutions
To begin, families have the option of creating a legal entity to own the asset. This can be a Family LLC, a partnership or a trust. The best choice depends upon each family’s unique situation. A sensible alternative is creating a Limited Liability Corporation, ideally while the original owners—the parents—are still living. The organizational documents include a certificate of organization to file with the Secretary of State and an operating agreement. The LLC will need its own taxpayer identification number, or EIN.
The operating agreement governs the management of the property and addresses the operating expenses and maintenance of the property. It should also address the process for a child to cash in on their ownership to other children. LLC operating agreements often include these items:
Named management—ideally, two or three people who are directly responsible for managing the LLC. This typically includes the parents or grandparents who set up the LLC or Trust. However, it should also include representatives from different branches in the family.
Property and ownership rules must be clarified and documented. The property’s use and rules for transferring property are a key part of the agreement. Does a buy-sell agreement work to give owners the right to opt out of owning the property? What would that look like: how can the family member sell, who can she sell to and how is the value established? Should there be a first-right-of refusal put into place? In these situations, a transfer to anyone who is not a blood descendent may require a vote with a unanimous tally.
There are families where transferring ownership is only permitted to lineal descendants and not to the families of spouses who marry into the family.
Finances need to be spelled out as well. A special endowment can be included as part of the LLC or as a separate trust, so that money or investments are set aside to pay taxes, upkeep, insurance and future capital requirements. Anyone who has ever owned a house knows there are always capital requirements, from replacing an ancient heating system to fixing a roof after decades of a heavy snow load.
If the endowment is not enough to cover costs, create an agreement for annual contributions by family members. Each family will need to determine who should contribute what. Some set this by earnings, others by how much the property is used. What happens if someone fails to pay their share?
Managing use of the property when there is a legal entity in place is more than a casual “Who asks Mom and Dad first.” The parents who establish the LLC or Trust may reserve lifetime use for themselves. The managers should establish rules for scheduling.
For parents or grandparents who create an LLC or Trust, be sure it works with your estate plan. If they intend to keep the property in the family and wish to leave a bequest for its maintenance, for instance, the estate planning attorney will be able to incorporate that into the LLC or Trust.
Costs & Benefits
There are some costs associated with creating an LLC, including annual filing requirements. However, these will be small, when compared to the cost of family fights and untangling joint ownership.
An LLC can also offer personal liability protection from lawsuits brought by renters, creditors, or any litigants. If there is an accident resulting from work being done on the property, the owners may be shielded from the liability because they do not personally own the property, the LLC does.
In the case of divorce, bankruptcy filing, or a large judgement being filed against one of the children, the LLC will protect their interest in the property.
The real estate owned by the LLC is not part of the owner’s probate estate. This avoids the need for a second probate in the state where the property is located. Some states have adopted the Uniform Transfer on Death Security Registration Act, and the LLC membership interest can be assigned along to the terms of the beneficiary designation.
Take the Next Step
Planning for what will happen to a vacation home after death provides peace of mind for all in the family. Speak with an experienced estate planning attorney to ensure that the property and the family’s peace is preserved.
Book a call with us today.
Reference: NH Business Review (March 23, 2022) “Succession planning for the family lakehouse”
Reference: Pauls Valley Democrat (July 29, 2021) “Estate planning for vacation property”
