Question: I have a vacation home that I want to leave to my three children but I am not sure how to do so. Do you have any suggestions?
Answer: There is no one way to leave a vacation home to children or other beneficiaries. One common approach is to create an entity such as a limited liability company (an “LLC”) to become the owner of the property. Corporations are typically not the entity of choice for purposes of holding real estate. While it is relatively easy to transfer real estate and other assets into a corporation, there are often tax consequences in transferring real estate and other property out of corporations, even if the transfer is made back to the contributing shareholder. With an LLC, on the other hand, once an LLC takes title to the real estate, the property can usually be transferred out of the LLC without tax consequences. LLCs, like corporate entities, offer asset protection, as the owners, called members in the LLC context, are not generally speaking personally responsible for LLC obligations.
Once a decision is made to transfer a vacation home to an LLC, the next decision is who the LLC owners will be. In many cases, it is not desirable for all of the children to become members. Oftentimes, children have different interests and some, particularly those who do not live proximate to the property, may not want to be part of vacation homeownership. A parent creating a vacation home LLC for children where less than all of the children will become members will have an additional issue to address. That is, a decision must be made as to whether the parent wants to pass additional assets to the non-participating child to compensate the child for not becoming an LLC owner.
LLCs typically have governing documents called Operating Agreements and LLCs created for vacation homeownership are no exception. While the children’s economic and voting rights may be the same, circumstances often arise where children do not agree on matters pertaining to the home, hence the need for a written Operating Agreement. Although a majority decision may be the rule, you may want to allow for situations where unanimity is required. Decisions such as when to sell the home, whether to make significant home improvements and whether to mortgage the property are often best decided by a unanimous vote.
One paramount issue with multiple vacation homeowners is succession. A common concern is what happens if a child no longer wishes to be part of the homeownership. A mechanism can be included in the Operating Agreement for a child to be bought out by the other children. In such case, the Operating Agreement should specify the purchase price, the methodology for determining the purchase price, whether by appraisal or otherwise, the method of payment, be it cash upfront, deferred payments or otherwise, and other issues. Any succession issues should also take into account what happens upon a child’s death. The options in this case would include permitting a child to pass the child’s interest to the child’s beneficiaries, allowing for a child’s interest to be forfeited or having the child’s membership interest being repurchased from the child’s estate.
Financial considerations are by necessity a part of the arrangement. As with any home, there is a requirement for cash for real estate taxes, insurance, repairs and maintenance and other operating expenses. The Operating Agreement must specify how payments are to be made and how and when members must contribute cash for such payments. In some cases, a parent creating a vacation home LLC will also fund the LLC with a meaningful amount of cash to cover the operating expenses, either for a period of years or in some cases in perpetuity. Perhaps the most significant issue of all is creating a mechanism for the children to share in-home usage, whether by schedule or otherwise.
Despite what seemingly is a simplistic task, determining how to leave a vacation home to children can be cumbersome. Many choose to avoid the issue by simply leaving the legal interest in the home to the children and letting them create their own arrangement. If you anticipate that the home may be something the children want to maintain for years to come, you may be better served by putting the ownership vehicle in place now while you are alive and able to do so.
The Tax Corner addresses various tax, estate, asset protection and other business matters. Should you have any questions regarding the subject matter or if you have questions you want answered, you may contact Bruce at (312) 648-2300 or send an e-mail to bruce.bell@sfbbg.com.
