Maybe it’s a lake home that’s been a family destination for generations, a place where grandchildren learn to ski and spend their days with cousins at the sand bar. Or maybe it’s a beach cottage where your kids bring their friends and the days are filled with laughter. Your family’s vacation home is likely a haven of lifelong memories. So how do you ensure it survives for generations to come?
A family vacation home is a unique asset that deserves suitable planning for decision-making and managing transitions within the family. Advance planning is critical not only for ensuring that the home will be truly multi-generational, but also for the survival of healthy family relationships that could otherwise be strained by disagreements.
Although there are several ways to plan for a family vacation home, this article focuses on the utilization of a Limited Liability Company (LLC) as a superior vehicle to hold and maintain the legacy of the family vacation home.
Ask First, Plan Second
The first matter to address is gaining a clear understanding of what you, your children and possibly your grandchildren would like to have happen to the family vacation home. It’s possible that not everyone is on the same page. Assumptions can jeopardize family harmony. Key questions include:
- Does the next generation really want to keep the property in the family, or are some family members looking to cash-out?
- Do some members of the family live far away and rarely use the vacation home?
- How will the expenses be funded so everyone can afford it and be responsible for it?
Parents should have a frank and open discussion with their children as to how all foresee the future use and ownership of the property. If the goal is to keep the property within the family, then the next step is to plan how to structure the LLC in a way that will preserve family harmony.
Limited Liability Company (LLC)
The attractiveness of an LLC is that it provides the transferability and operational flexibility of a partnership along with the limited liability protection of a corporation1.
An LLC is governed by an Operating Agreement, which can be tailored to meet the unique needs of multiple generations. It is used to establish a system for managing and controlling the property, restricting transferability of ownership interests, preventing and resolving disputes among family members and providing estate planning and gifting options.
- Asset Protection
An LLC has the potential to limit liability exposure by protecting the LLC members from the creditors of the LLC and by protecting the LLC from the creditors of the LLC members. For example, if someone is injured on the property and files a judgment, only the LLC assets are at risk. The members’ personal assets are protected from exposure to the claim. Likewise, if an LLC member has a personal claim against them, the member’s LLC interest is shielded from the creditor.
An LLC can be structured to give control to either a minority or a majority owner. Thus, a parent can retain control even after transferring much of their ownership interest in the LLC to their children and grandchildren.
- Tax Benefits
There is a distinct tax advantage to transferring an LLC interest as opposed to the assets held inside of an LLC. The LLC wrapper allows you to engineer discounts and maximize the use of the estate exemption. You can leverage gifts to future generations by applying valuation discounts to gifts of LLC interest.
An Operating Agreement serves as a rulebook for managing the property. The Operating Agreement addresses a wide variety of issues, including those that may be specific to your family dynamics. A well-conceived governance structure may minimize the likelihood of disagreements among family members.
Key Governance Considerations
The LLC Operating Agreement sets forth the rules of engagement for the entire family and should contain considerable detail, including the following:
- Transfer of Interest
Transfer restrictions stipulate who can be a member of the LLC and the constraints on transferability of ownership to non-permitted transferees. These terms can potentially prevent members from selling their interest to someone outside the family.
- Care and Maintenance
The LLC members need to agree upon how expenses will be funded, how the decision to approve the expenses will be made and who will handle the administrative items regarding maintenance or future improvements. Expenses can be funded in a number ways. Parents can contribute assets when the LLC is funded to create an endowment fund or purchase life insurance that will pay out to the LLC on their death. These options ensure that the property will be truly multi-generational by allowing all generations to use the home equally regardless of their own finances. Alternatively, expenses may be required on a pro rata basis, based upon future ownership or property usage.
- Real Estate Usage
It will be important for everyone to have guidelines regarding the use of the property. This includes who can use the property and when, as well as the expectation of the condition of the property for the next user. These proverbial ‘keep the peace’ rules are typically established by the patriarch and matriarch of the family and can be memorialized in the Operating Agreement.
Finally, mechanisms can be put in place to address disputes regarding when to sell the property, which may require a majority vote, super majority vote or unanimous vote of the members. Alternatively, a buy-sell provision can be used that sets forth the process, price and terms of a member’s sale of their interest in the LLC in the event that one member wants to sell the property but the other members do not.
An LLC marries the world of corporate governance with the soft and emotional issues surrounding a family’s love of their vacation home. Together with your team of advisors, your Oxford partners can structure and guide the details and nuances to ensure generational enjoyment of your family’s legacy home.
1 An LLC is a separate legal entity and requires that certain formalities be followed in order to reap the benefits that the entity structure provides. These include executing and following a legal Operating Agreement: maintaining a separate checking account for payment of expenses with no commingling of personal funds; holding annual member meetings and submitting annual filings to the State and IRS; and maintaining sufficient general liability insurance on the property.
The information in this presentation is for educational and illustrative purposes only and does not constitute investment, tax or legal advice.