Given that summer is here, planning for the future of your family vacation home seems appropriate. A cottage can represent a significant portion of a family’s wealth and history. If purchased many decades ago, it has likely appreciated in value many times over. Children may have grown up spending their summers on the beach or lake and have strong emotional ties to it. But a family cottage has considerable expenses associated with it, including taxes, insurance, and repairs. What will happen when the parents are gone? Will each child be willing and able to share it equally?
Understandably, parents want to treat their children equally. To keep things simple, they usually just leave the beach house outright to their children. We often hear, “They will work it out, don’t worry.” What many families do not understand, is that a family cottage can be a legal nightmare. Every owner has a legal right to seek partition of the real estate. A partition suit asks a judge to either physically divide the property or sell the property and divide the proceeds. With a vacation home, a judge will usually order a sale and divide the proceeds. When parents give the beach house to the children outright, they risk a partition sale.
Why might a partition sale occur? A child might get a divorce, the ex-spouse receives a share of the beach house in the divorce decree, and then the ex-spouse seeks a partition sale. A child might incur debt for a business or lifestyle, default on the loan obligations and/or file bankruptcy, have his or her share of the beach house liened, then the creditor or a bankruptcy trustee ask for a partition sale. Even more common, a child might move away for work, or love, and then seldom visits the beach house. He or she might be unable or unwilling to share in the beach house expenses. The other children might not wish to buy out his or her share. Eventually, the faraway child files suit seeking a partition sale. The child justifies the sale as simply claiming a fair share of his or her parent’s estate.
Even if a partition sale does not occur, the beach house could cause a major rift in the family. Sometimes a child cannot afford to share in the beach house expenses. The other children rightfully think that it is unfair that they must bear the burden of carrying the beach house. The resentment can grow over the years and lead to a permanent rift between them.
How do you avoid this predicament? You could give the cottage to one child. But how do you choose which one? Should you base the decision on ability to bear the expenses, the frequency of use of the beach house, or the amount of assistance a child might be providing to the parents? Most parents prefer not to choose among their children because they believe it will cause long-term resentment in the family.
There is a better way. This solution can preserve family relationships, treat all children equally, and avoid a partition suit. It involves transferring the cottage while you are alive, or after your death, to a limited liability company (LLC). In the LLC operating agreement, the children waive their partition rights. The agreement clarifies the method for sharing expenses. The agreement can allow the family to restrict use, impose a fine, reduce the ownership share, or buy out a child who no longer is able or willing to share in the property’s expenses. It can give a child, who has moved away, the option of requiring the family to buy out his or her share. Such buy out options are usually for less than fair market value and allow payment over a series of years. The agreement will restrict who can become an owner of the cottage so that the family does not have to worry about creditors or ex-spouses. The family could avoid the problem of multiplying heirs (and hence, owners) by allowing voting and transfer of shares by family branch, instead of individually. The agreement can give the children the right to maintain and improve the beach house and compel contributions for such improvements. The family could control the use of the cottage through the agreement so that one child (or the child’s guest) does not monopolize the use of the cottage. The agreement can also provide compensation to a child who lives near the beach house and bears a disproportionate burden of maintaining and renting the house.
There is a wonderful book on this topic entitled “Saving the Family Cottage: Guide to Succession Planning for Cottage, Cabin, Camp or Vacation Home.” Stuart and Rose Hollander and David Fry wrote this seminal work and are on their 5th edition. You can find it at any online bookstore. It is easy to read and makes the whole topic understandable. Give it a read and visit us at Cipparone & Zaccaro, P.C. We have many years of experience specializing in helping families create LLCs to manage and save the family cottage. We can help you create a wise succession plan.
July 2020, Issue # 28
Joe Cipparone wrote the articles in this edition. No taxpayer can avoid tax penalties based on the advice given in this newsletter. This information is for general purposes only and does not constitute legal advice. For specific questions related to your situation, you should consult a qualified estate planning attorney.
