Leaving the summer cottage to your children? Consider an LLC
The Cape house may be shuttered tight for the winter or perhaps it’s the seaside cottage in Maine. But for many, that memory-filled family retreat is far from secure. A big question: what will happen when it’s time to pass the property to the next generation.
The most common approach is to simply leave it to the kids. But there are pitfalls. Just ask Marge Albin, who inherited a one-third share of the family vacation home on Cape Cod. The three siblings initially shared responsibility for the Chatham house. But issues such as making improvements, arranging maintenance, or even buying new deck furniture got “contentious and uncomfortable,” Albin said.
Then the water heater broke. Undiscovered, the basement flooded and then filled with black mold. Albin, who lives in Lexington, said the repairs were the last straw. She told her brothers, “That’s it. I’m out of here. You can buy me out or we can sell.” So they sold.
It doesn’t have to be that way, said Michigan attorney David Fry, who watched his mother get squeezed out of a vacation property that had been in the family for three generations. A corporate lawyer by training, Fry said that experience eventually led him to a law practice that’s now 90 percent clients wishing to preserve what he calls “the family cottage.”
His first family cottage job was helping his wife and her siblings establish an ownership structure that would preserve her family’s lake property. That led to the next job and beyond. Today, his business backlog has never been bigger.
“A lot of ownership is maturing,” he explained, noting that baby boomers are tackling a variety of estate planning issues, including the family cottage.
Consider the case of Mary Shaw, who has owned waterfront property on Lake Michigan for nearly 30 years. With three grown daughters, each with a family, Shaw and her husband have been pondering the best way to pass the property to their children, who all say that they want to preserve the retreat.
“Who pays the property taxes? What happens if the roof needs to be replaced? And how are they ever going to figure out who gets the house for the Fourth of July,” Shaw said, noting that one daughter lives in New York, a second in Ohio, and the third in Chicago. All three have different lives, incomes, and interests.
For people like the Shaws, Fry suggests using a limited liability company, or LLC, which then becomes owner of the property. LLCs combine the liability protection of a corporation with the operational flexibility and tax efficiency of a partnership.
Once set up, mom and dad initially own the LLC. Over time, or upon their death, shares of the LLC are transferred to their children, who become co-owners.
When establishing an LLC, owners get to set the rules for how the property will be managed. As such, the next generation inherits a management structure along with the LLC shares. The rules, for example, can be used to create a system for determining a calendar for use of the property. They can establish a management committee and decide how decisions are made. They can also prohibit the sale of the LLC property to anyone who isn’t a lineal descendent, establish steps that must be taken should one family member wish to sell, and even devise the formula for determining the sales price and payment terms.
Without those rules, family members can quickly lose control of the property, said Chris Perry, a senior fiduciary officer at The Northern Trust Co. in Boston. In a family with three children and no LLC, for example, one child might file for divorce, making his or her one-third of the cottage a marital asset subject to the divorce settlement, he said. Perhaps the second child dies, leaving three children who then inherit the LLC shares. And the third might decide to sell to someone outside the family.
“We’ve seen litigation ensue,” Perry said.
If they want, parents also can fund the LLC, creating an endowment-type vehicle that can be used for property upkeep, improvements, and taxes. Perry said he typically recommends that parents initially put some cash into the LLC.
For some, giving away LLC shares can be a good estate planning tool. Restrictions on the sale of a property actually lower the value of the shares compared with the value of unrestricted property, Perry said, noting that has the effect of lowering the value of the gift. “Massachusetts doesn’t have a gift tax,” he said, “so making a gift and getting it out of your estate can also be a benefit.”
Still, the LLC approach isn’t for everyone. Fee-only financial adviser Beth Gamel of Argent Wealth Management in Waltham, said that sometimes children just don’t want the family cottage. In advising clients, she has found “the kids weren’t always as attached to the house as the parents thought they were.” That’s why the first step in any such planning process should be an honest family conversation, she said.
In retrospect, Marge Albin says selling the Chatham vacation house was the right decision for her family. “We could never get back what that house meant when our parents were alive,” she said. Now, eight years after selling, the bad feelings and resentments between siblings have disappeared.
“Our relationship today is terrific,” Albin said.