Vacation Home Planning- What Happens to the Family Cottage after the Kids Inherit It?
Posted: October 30, 2021
Written by Attorney Peter J. Smiley, J.D., MS- Tax
My grandmother owns a cottage in central Wisconsin on a quaint little lake that I have visited for longer than I can remember. A few years ago, the discussion arose about how to best transfer the property for future generations. As my grandmother found out, when your grandson is an estate planning attorney, you get a much more enthusiastic and detailed answer than she was likely expecting.
Vacation Home Problems Few People See Coming
Discussions about real estate that clients hope to pass on to their children and more distant heirs comes up regularly in our practice, which is hardly surprising given the abundance of families that own lake houses, hunting land, and general “Up North” property in Wisconsin, Michigan, Illinois, and Minnesota.
Trying to keep real estate in a family for more than one generation presents many challenges. Sometimes families give real estate outright to multiple children to share. If multiple owners are named on a deed, this means that every time some portion of the property changed hands, a new deed needs to be filed reporting the new ownership of the property. This can cause an exponential growth in the owners of a property over the years, as a single original owner transfers the interest to their children, and, eventually, to the grandchildren, etc. It also raises many challenges if someone wants to sell their interest in the property or gets divorced.
I have personally seen a single deed with over a dozen names on the deed, which can complicate matters if the property is sold (as each owner has to sign off on the sale of their share and agree to the purchase price and terms). It can also cause significant interfamily strife if there aren’t clearly defined rules for who can use the property at any given time, or who is responsible for how much of the property taxes each year. Even worse, clients have shared horror stories about battles fought over paying for significant repairs or remodeling expenses.
When I discussed these concerns with my grandmother, she was (rightly) very concerned. Her hope was that the cottage would be a source of family togetherness, not a cause of friction. That is when I told her that in recent years there has been increased use of a tool that allows her to address virtually all of the issues identified above.
The Vacation Home LLC: a Powerful Planning Option
Vacation home LLCs allow a family to preserve the property while setting out rules for the maintenance, use, and care of the property, as well as streamlining the long-term management of the property. Over the last 20 years, the Vacation Home LLC has grown from a little-known technique to a more common practice (Andrew Willms, our firm’s founder, has been recommending this type of planning for decades).
For example, grandparents can create an LLC of which they initially own 100% of the ownership units (think of these units like stock in a corporation) and transfer their vacation property into the LLC. The grandparents can gift the LLC units to their children as they see fit during life, or transfer the units upon their death. However, there is only one name on the deed (the name of the LLC) and an LLC manager is named as the point person to make major decisions. An operating agreement can be established for the LLC that sets forth the ground rules and manager responsibilities, such as:
Use of the Property. A vacation home LLC’s operating agreement can set forth protocols for using the property. For example, a lottery system or calendaring system can be established for assigning use of the property, and a Manager can be given discretion to settle disputes about property use. Certain days (like the 4th of July) can be labeled “open” days that everyone can use the property, while other days can be privately assigned. Unit owners can also lose rights to use the property if they are unduly disruptive, violate LLC rules or fail to contribute their fair share of expenses.
Expenses. A vacation home LLC will typically have one dedicated LLC bank account used to pay expenses. The vacation home LLC’s operating agreement can tie privileges to use the property with the requirement to contribute for expenses. If a child becomes delinquent on these payments, their use of the property can be placed on hold until they contribute their share. When it comes time to repair the roof (for example), the unit holders can vote on how much to spend, and each person or family will be responsible for their pro-rata share. Additionally, some clients will choose to fund these LLCs with an initial cash contribution or a bequest in their will or trust, to cover future costs associated with the property for a period of time.
Transferability Restrictions. An LLC operating agreement can limit the transferability of LLC units. Some clients will specifically allow their lineal descendants to own the property, but not the spouses of those descendants. Others will allow spouses or even third parties to own the units. The options are limited only by the wishes of the parties that establish the LLC. Furthermore, the LLC agreement can provide for the terms which the other unit holders can repurchase another member’s shares, on either a voluntary or mandatory basis.
Liability Protection. If there is a slip and fall or other incident at the property, a limited liability company can help protect the unit owners from personal liability. However, the LLC should still carry adequate insurance and keep the property in safe operating condition.
Flexibility. Vacation home LLCs also provide flexibility for future generations because the operating agreement can be amended in the future pursuant to the terms of the document (for example, by majority vote, or unanimous vote, depending upon the significance of the change). This allows revisions to be made down the road as circumstances change.
In our example, the grandparents can feel confident that even when their multiple grandchildren own the vacation home many years from now, they have a framework in place to settle disputes and help ensure the property does not become burdensome or a source of conflict.
While I am sure that my grandmother was not expecting such a deep dive into the world of multigenerational planning, once I explained the benefits from creating a vacation home LLC, she decided to proceed.
If you have property in your family you hope to retain for multiple generations, I would be happy to discuss with you whether a vacation home LLC might be a good planning tool for you.