Having a vacation home is a dream for many people. In the last Viewpoint, we discussed important considerations when buying a second home. However, there are just as many things to think about when it comes to keeping the family vacation home for future generations.
The following are three big ideas to keep in mind as you prepare for this potentially tricky and stressful process. The good news is that these ideas will not only help preserve the family home, but also preserve family harmony. Optimally, the time to think about these issues is before the last parent or original owner passes away.
1. Vacation homes are best owned by limited liability companies
It is commonly assumed that the best way to pass on a second home is to simply transfer ownership down to the next generation, with equal shares going to each individual child or grandchild. In other words, three recipients would each receive 33% of the home; four individual owners would receive 25% each, and so on. But this supposedly simple and fair approach presents many difficult issues. For instance, what happens if one child does not want to own or use the home and prefers to sell his or her share? And what if one owner wants to use the home for long stretches of time, while another is more interested in rental income?
These are difficult questions, from both a financial management and emotional perspective. That’s why structuring home ownership through a limited liability company, or LLC, is a very useful strategy. LLC ownership offers the following significant advantages over individual or trust ownership:
- Insulation of owners’ personal assets from liability and creditor protection if a renter or tenant sues for negligence occurring on the property.
- Flexibility in that a LLC may exist for as long as necessary (in this case, for however long the family wants to own the home), whereas trusts may be required to terminate after a specific period of time.
- Clear decision-making authority and roles and responsibilities for family members with interest in the LLC, as opposed to trusts, which typically require a single trustee to make decisions and may raise conflicts among siblings.
- An easier mechanism for transferring ownership through gifts to future generations.
2. Operating agreements should be detailed and specific
When it comes to LLC ownership, detailed operating agreements should answer both important big-picture questions and provide a process for day-to-day management. “The more detailed the better” is a good rule of thumb when it comes to drafting these documents. Issues that should be addressed include:
- The process for selling the home: Under what circumstances may the house be sold? Do all family members (or owners) have to consent to sell the home? What happens if only one child wants to sell home?
- The process for transferring LLC ownership: In the event that one family member (or owner) wants to sell his or her LLC ownership interest, how will fair market value be determined? Are multiple appraisals required? Can interest be sold to a third party or non-family member? Do current family members have a right of first refusal?
- Day-to-day management of the home: Who is responsible for overseeing the upkeep of the home, including paying property taxes and utilities? Who will ensure the home and grounds are properly maintained? Are decisions made by one individual or is a majority or unanimous vote required? If the home is rented, how is the rent determined and how will income and expenses be allocated? What are the rules for using the home?
These may sound like minor issues, but they can snowball into major problems without clear and comprehensive documentation. In our experience, handshake agreements are simply not sufficient to cover all of these details, even in close and trusting families.
3. Don’t overlook the emotional factor
Owning a vacation home can lead to strong emotions and even strain family ties, especially if it’s undertaken in the immediate aftermath of a parent’s death or if siblings find themselves in very different financial situations. Again, a clear and well-structured operating agreement can help alleviate some of the tension – especially, if they are defined well in advance and communicated to everyone. We highly recommend Saving the Family Cottage, by Stuart Hollander, as an excellent source of guidance to individuals or families who find themselves facing these questions.
We certainly recognize that owning a second home can sometimes feel like a second job, but these tips are designed to help remove friction from the process of family ownership, especially when there are multiple siblings. And they increase the likelihood that the home can stay in the family, if that is the goal of one or more family members.
While the management of an LLC may be the last thing you want to think about when you’re on vacation, careful planning about the future management of the property can help address many typically avoidable conflicts. In fact, our experience with various clients confirms that owning the home in an LLC helps family members enjoy it more fully.