Owning a vacation home can create cherished memories for you and your family. For many, these are thoughts of times together, playing in the sand at the beach, running after seagulls and the ringing bell of the ice cream truck. For some it is the memories of carving fresh snow, gathering rosy cheeked around a crackling fireplace at the ski lodge to enjoy a warm beverage. Whether yours is a beach front cottage or a ski cabin, the sentiments are likely the same. The place holds sentimental value that is passed down from one generation to the next.
Unfortunately for some, a family cottage can also be the source of great conflict and hostility for successive generations. When the two parents own the home, the chances for disagreement are minimal. However, what happens when the two parents pass the house on to their seven children? Suddenly, the house has seven owners instead of two. If the house is ultimately passed down to the grandchildren, you may end up with twenty co-owners. Can you think of any problems this might cause?
When multiple people inherit a home, they typically take the property as Tenants in Common. This means that each owner has an undivided interest in the whole of the entire property so that even a 1% owner has the same right to occupy the entire property as a 99% owner. Also, a tenant in common can sell, give or loan her interest to anyone she chooses. If irretrievably upset about the management of the cottage or wishing the property was sold to pay his or her debts or pursue other dreams, an owner can file a partition action in court to force the sale of the cottage. Outright ownership by multiple family member is not ideal when the goal is to keep the cottage in the family as a source of happy memories. Fortunately, most conflict can be easily avoided through use of an appropriately structured Limited Liability Company (“LLC”).
First, let me explain briefly some of the relevant background of LLCs. The owners of an LLC are referred to as members. The members can control the governing of an LLC by entering into an operating agreement, with written rules, obligations, restrictions and conflict resolution procedures. LLC members can also appoint a manager of the LLC to centralize decision making and operating control in one person.
Let’s look at a few issues that arise with multiple owners of real estate and how using an LLC can resolve those issues.
Capital contributions
A house comes with recurring expenses, such as mortgage payments, maintenance costs, real estate taxes, and insurance. What remedy is there when a co-owner refuses to contribute toward these costs? Under a Tenancy in Common, you have little remedy if a co-owner decides not to pay an expense. You cannot lawfully exclude a co-owner from use of the property for not contributing. With an LLC, you can create rules that require a member to be current on capital contributions in order to enjoy use of the property and cause forfeiture of a member’s share for extreme delinquency after notice and a period of time to contribute.
Management
Who will be responsible for monitoring, cleaning and maintaining the house and yard? Will that person be compensated? A tenant in common owner cannot force other co-owners to do these tasks, and is not automatically entitled to compensation for performing them herself. LLC members can assign responsibility for these tasks and decide in advance on a method to compensate the member coordinating these services.
Prime Time Use
What happens when all twenty co-owners show up to the cottage on the 4th of July? Under a tenancy in common, all owners have the legal right to use the cottage at all times. By using an LLC, the members can spell out a fair method for dividing up and alternating use of the prime vacation times and prohibiting members from using the cottage outside of their allotted times.
Squatting owner
What can you do when a drug addicted co-owner loses his job, takes up permanent residence in the home with his destructive dog, and throws wild parties at the cottage? You can do nothing under a tenancy in common. All owners have the right to use the property at any time. An LLC can restrict the length of time an owner can reside in the home and can also place restriction on pets, substance abuse and the number of guests allowed.
How can you keep the cottage in the family? - What happens if a co-owner sells or gifts her interest to a non-family member? What happens when a widowed in-law inherits the property then remarries, or worse, a disgruntled ex-spouse takes ownership through a divorce proceeding then remarries? What happens if a judgment creditor takes possession of a co-owner’s share of the property? Under a simple tenancy in common, these are common scenarios. An LLC operating agreement can limit the transferability of a member’s interest to the other LLC members to prevent these occurrences.
Cashing out
What if a co-owner who wants to cash out her share? What is the value? Will there be liquidity to pay for the buyout? What if the co-owners refuse? A tenant in common owner can force the division and/or sale of the property in a legal partition action, which can be an expensive proceeding that often results in less than a fair market value return. However, an LLC operating agreement can prevent a partition of the property and devise a fair way to value the interest of a member and compensate that member who wishes to cash out. The LLC operating agreement can discount the purchase price for family members who want to remain owners and keep the property in the family.
Discussing these issues with family members while the parents are alive can make it easier to resolve them before any conflict arises. Ensure the future of your family cottage by contacting us to help you create an LLC today.
