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Jun 2006
01
June 01, 2006

Your Vacation Property: Tips to Keep It All In the Family

When the future of the family vacation home is under discussion, family members' emotions tend to be strong, and the financial stakes are often high. Warm memories of time spent at the "cottage" -- whatever its location, size or value -- spark a desire to keep it in the family for generations. As a place where family members come together to relax, a vacation property is the glue that binds the family together. At the same time, its current fair market value may represent a large part of an estate, with the promise of continuing appreciation in the future, making it a financially valuable asset to keep.

The first challenge for owners is determining how to transfer the property to the next generation with the least tax cost. The transfer can be handled in many ways: by gifting undivided interests in the cottage each year to individuals, by gifting the property to an irrevocable trust, or by placing it in a limited liability company or limited partnership and gifting interests in the LLC or partnership.

There are several advantages to using trusts or LLCs. These vehicles offer the ability to transfer interests at a discounted tax cost, avoid probate in the state where the property is located upon the death of an owner, and protect the home from the next generation's creditors. Nonetheless, these vehicles are more complex and costly than outright ownership.

While each form has its advantages and disadvantages, the LLC form offers the greatest flexibility. If the owners contribute funds to maintain the property, there are fewer tax issues with an LLC compared with a trust. In addition, the owners can easily amend the LLC agreement to change the rules, duties and obligations of the owners and users over time. For instance, perhaps when the LLC is originally created, the agreement prohibits members from withdrawing during their lifetime. As time progresses, however, the family agrees that lifetime withdrawals should be permitted in some circumstances. With an LLC, the family can easily amend the terms of the agreement to permit a lifetime withdrawal, and specify the terms of doing so.

Creating an owners' agreement

Regardless of the form chosen for transferring the cottage to the next generation, it will be essential to have a written agreement setting forth rules and procedures so the property can be successfully maintained, managed and owned by multiple family members for many years. Even if individuals own the property outside of a trust or LLC, joint tenancy agreements can specify the terms of ownership, management and use. If a trust or LLC is used, these terms would be specified in the trust or LLC agreement.

While it is tempting to ask your attorney to draft up an agreement to which all owners will be bound, clearly the best approach is to give all current and future owners a say in how the property will be held and managed. Attempting to impose obligations, burdens and restrictions on owners without their input is a recipe for disaster. Written questionnaires or family mediators, can be helpful, enabling family members to state their desires and thoughts anonymously.

Questions that should be asked of the next generation include:

  • Do you have an interest in owning the cottage?
  • Which decisions about maintenance, use and management of the cottage property should be made by all owners, and which decisions should be made by a smaller committee?
  • Under what circumstances should a sale to an outsider be considered, and who will make the decision?
  • Should transfers be permitted among owners and their descendants? How will price be determined?
  • Can family members be bought out, and if so, what will be the price and payment terms? Should a discounted price be paid in order to discourage withdrawals and reduce the financial burden on those who continue to own the property?

The agreement should specify how funds will be collected to pay for expenses related to the cottage. Because different owners' interest in using the property (or ability to use it) may vary, membership dues, special assessments and usage fees can permit the financial burden to be spread among the family to reflect differing degrees of use and ownership. Such fees can promote fairness while also basing part of the burden on ownership of the property.

Membership dues are typically charged equally per owner. By contrast, as the name implies, usage fees are charged according to actual use, similar to rent. Finally, special assessments can be levied based on actual ownership percentages. By modifying how these three charges are assessed, you can tailor the agreement to fit your family's needs and promote a sense of equity in the property.

The agreement should also specify how decisions will be made on several other issues. For instance, it may be appropriate for a smaller committee or group of managers to make some of the routine decisions and be responsible for bill paying, while other decisions may be so important as to require a vote of all owners. Examples of the types of issues that might be addressed include:

  • Handling of routine expenses, such as property taxes, insurance, utilities, and house cleaning.
  • Handling of non-routine expenses, such as replacement of docks or decks, roof or plumbing repair, redecorating and purchase of new appliances or furnishings.
  • Determining who will use the cottage, and what rules users must follow.
  • Potential rental of the home to third parties.
  • Sale of the property.
  • Payment of expenses above a stated dollar amount.
  • Mortgaging the property or refinancing existing mortgages.

It is important to realize that a written agreement will not be able to resolve all issues that may arise over the years. But the creation of a written agreement requires the owners to think about issues in advance and reach an accord outside of the heat of the moment. The agreement also lays an important framework for resolving disputes; it sets forth the rules of engagement and the dispute-resolution procedure. These benefits can be invaluable in a time of crisis, allowing energy to be spent on the issue at hand.

Ultimately, the key to successful ownership of a family vacation home lies in encouraging buy-in to the concept of keeping the cottage in the family, as well as establishing fairness in the financial and non-financial aspects of ownership. Removing perceived inequities in use or financial burden can allow family members to enjoy the property for years to come.

Family Business Magazine

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