Keep Your Family Cabin in the Family
Your vacation home likely holds some of your fondest family memories, a tradition you’d like to pass on for generations. For many families, simply leaving the property outright to the next generation is not the best way to transfer your vacation home. More often than not, joint ownership leads to family disputes regarding how the home is used, operated, maintained, and improved. If this doesn’t sound like the fun family memories you’d like to pass along to your grandchildren, then it’s time to explore some other options with your attorney.
One option for the transfer of vacation home real estate is the use of Limited Liability Companies (“LLCs”). LLCs are quickly becoming the preferred entity for vacation homes because membership interests in an LLC are easily transferrable outside of probate, and LLCs provide for flexible operating agreements that allow for the parties to define individual’s financial duties, access, and responsibilities for the property. Unlike joint ownership that leaves all of these issues up to the individual owners to figure out on their own, an LLC allows the parents, or the first generation of owners, to decide how the property should be managed.
Ownership of vacation homes through an LLC offer several unique advantages:
- Liability Protection for the Owners for Liability Relating to Real Estate. Ownership through an LLC offers personal liability protection from lawsuits by creditors, renters, and users of the real estate. In general, members or owners of an LLC have significant protection from personal liability relating to the real estate owned by the LLC. For instance, if there is an accident at the vacation home, which causes personal injury to a third party, the owners of the LLC may not be sued personally for that injury.
- Protect the Property from the Owner’s Creditors. If the individual owners have creditor issues, state laws do not allow a creditor to become an owner of an LLC or force any asset within the LLC to be sold simply because the creditor has a judgment against an LLC owner. This is particularly important if the LLC owner becomes divorced, files for bankruptcy, or has a large judgment against him or her.
- Ease in Ownership Transfer. The ease in ownership transfer is another benefit of an LLC. LLC documents ownership by membership units or LLC Interests. Upon formation of the entity, the vacation property is retitled in the name of the LLC. Thereafter, the original owners of the vacation property can give or assign interests in the entity in one transfer or in several over time, during their lifetime, or at death. This allows the original property owners the flexibility to retain control during their lifetime if such retention is desired.
- Avoids Risk of Petition of Real Estate. In the case of joint ownership, an LLC prevents property owners from using their right of partition to force a sale of the property.
- Operating Agreement Prescribes Rules for Ownership. The operating agreement for the LLC promotes shared governance and use of the property by setting forth the management provisions and the basic rules for the entity. This operating agreement structure can help settle or prevent disputes about who is responsible for expenses and maintenance. These provisions often include:
- responsibility for payment of operating expenses;
- procedures for transfer of member units or interests;
- duties and responsibilities of regular maintenance, budgeting, and approving property improvements;
- developing and enforcing use schedules for use of the property;
- establishing rules for use; and
- other considerations.
- Prevents Transfer of Ownership to Third Parties. LLCs prevent transfer of an interest outside of the family while also setting up a mechanism to allow family members “out” of the vacation home if they would rather not be an owner of the vacation home. The LLC operating agreement for a family vacation home can include transfer restrictions or “buy-sell” provisions. These provisions are intended to prevent the sale to an outside party without the agreement of the ownership; determine a method to transfer the real estate; set forth a method to value the real estate; etc.
- Probate Avoidance. Because the real estate is owned through an LLC, the real estate will not be part of any of the owner’s probate estate. Likewise, there will be no need for ancillary probate if the vacation home is located in another state. Most states have adopted the Uniform Transfer On Death Security Registration Act (the “Act”) and the LLC membership interests can be passed according to the terms of a beneficiary designation and are not controlled by the terms of the owner’s will. This means that the membership interests pass outside of the probate estate. Assets transferred via “transfer on death” registration still receive a full step-up in cost basis. Under the Act, individuals can also name multiple beneficiaries or contingent beneficiaries.
- Protection in the Event of Divorce. Ownership through an LLC, rather than individual joint ownership, is far preferable in the event of a divorce of one of the owners. A divorcing spouse cannot force a sale of the vacation home in the event of divorce.
- Perpetual Existence. LLCs can be established with a perpetual existence, which can give the family a sense of certainty. Membership interests can also be passed on the death of a member without the necessity of filing a deed.
A plan for your family vacation home is a critical part of an estate plan and ensures the succession of a key asset to family members long after the original owner has passed on. Planning early gives peace of mind that the succession objectives will be met and will foster communication among the family regarding their interest and intent. In addition to planning early, it is important to revisit the plan over time or whenever a change in circumstance arises.