In previous blog posts, we have explored whether your family wants to keep the family cottage or vacation property in the family, and the options for the form of ownership you want to use for the next generation. In this post, I discuss how to decide on some rules and create an agreement for using and maintaining the property and for a family member’s exit from ownership/membership should that become necessary.
The form and nature of the agreement setting forth the rules for the cottage will depend on the ownership structure you choose. Regardless of the agreement type, you will want to address the issues below and build in flexibility for the future, if possible.
Allocating Shared Property
Property usage and allocating expenses are probably the most important and potentially contentious issues for a family. With respect to use, and to preserve family harmony, your agreement should include the answers to these questions:
- Who will determine usage? A trustee, LLC manager or ownership committee?
- Will use be allotted using a lottery or perhaps first come, first served?
- How will usage over important holidays be allocated or determined?
- Is there a cap on how much each family member can use?
- Is usage in set blocks, such as Sunday to Sunday?
- How will unequal allocation be dealt with?
- Can usage swaps occur?
- Is use by non-family members permitted?
Use of Shared Property
Your governing instrument should also include a mechanism for establishing a separate Rules for Use document. These rules should be flexible and allow for changes as experience and circumstances dictate. Examples of rules could include:
- Food and beverage consumption and replenishment.
- Cleaning of the cottage and linens at the end of each use.
- Bringing pets.
- Friends’ usage and overnight stays.
- Prohibited activities.
Property Maintenance
Property requires constant maintenance and upkeep, which generally fall into two categories: routine and non-routine. Your agreement should address who will be responsible for making routine and non-routine decisions and what amounts a decisionmaker can spend without the approval of others to avoid surprises for the owners.
Payment of Expenses for Shared Property
Not all owners of the cottage may want to use it in equal amounts. In paying expenses, it is important to choose a manner that creates a sense of fairness between those who frequently use the property and those who don’t. Consider these alternatives:
- Assessments – usually assessed based on ownership percentages and reflect the cost of the privilege of ownership. In LLC agreements, this may be the “capital contribution.”
- Membership Fees – typically assessed equally among all owners, or perhaps equally by “family line” or “household” regardless of ownership percentage, to spread the burden of some expenses equally among all owners.
- Usage Fees (aka “rent”) – assessed based on actual use of the property, understanding that a below-market “rental rate” will encourage more usage.
Your agreement should specify the fees that will be used, the deadline for payment of fees and the consequences of failing to pay by the deadline. Some amount of time, perhaps 30 - 60 days, should be provided to a defaulting owner to pay his or her portion of expenses. Nonpayment can be treated as a loan, with interest, extended by the other owners and secured by the defaulting owner’s interest in the property or entity.
Budgets and Accounting for Shared Property
Your agreement should specify that an annual budget of anticipated expenses and income, as well as the proposed payment required of each owner and user, should be established early in the season and provided to all owners. March 1 is a common date for the required budget of Michigan property used in the summer months only. The date may be January 1 for year-round properties.
Annual accountings of how funds were spent the prior year are a best practice. This provides information on the cost of upkeep and creates accountability for the use of common funds, trust assets or LLC assets.
Decision-making for Shared Property
Your governing agreement should address who will make financial and management decisions, perhaps naming someone who handles routine expenses under a certain dollar amount and someone who can handle emergencies. The agreement should also specify types of decisions that must be made jointly by the owners, such as new construction or borrowing money, and the vote outcome required to approve a decision.
If the family is large, busy or always on the move, you may wish to form an ownership committee, perhaps appointing people responsible for different tasks. Your agreement will need to address the selection and removal process for the committee chair, the LLC manager and other positions.
Additionally, the agreement should address the dispute resolution mechanism to be used when family members disagree with decisions made or with the actions of other owners.
Exit Strategies for Shared Ownership
An exit mechanism is an important part of your governing agreement, because forcing family members to maintain the ownership and expense of a cottage when they are not willing or able to use it is never a healthy situation. It can foster anger and resentment between the owners and create issues with the ongoing management of the cottage. Questions to think about include:
- If voluntary withdrawals are allowed, what would be the purchase price and payment terms? How will the property value be determined?
- Should the other co-owners be permitted to expel an owner who repeatedly violates the rules of use or fails to contribute to their share of the costs of ownership? How would that work?
- Will transfers of ownership interests or LLC membership interests to others be permitted, and if so under what conditions?
Creating Your Ownership Agreement
Implementing your decision to pass the family cottage or vacation home to the next generation takes some careful thought. But creating a framework for them to co-own a valuable family heirloom should allow them to truly enjoy the use of this property for years to come. To start working through the process of transferring ownership to the next generation, contact your estate planning attorney or Mark Harder at mharder@wnj.com or 616.396.3225.
For more information, see our previous posts, Does It Make Sense to Pass the Cottage to Future Generations? and Ownership Structures for Shared Family Property.
