Succession Planning for Family Real Estate

    April 01, 2011, 02:57 PM

    An earlier entry discussed the importance of succession planning for the ownership of cherished family real estate such as beach and river houses, mountain cabins, farms, hunting grounds or other family retreats. Family limited liability companies (LLCs) have become the preferred vehicle for holding, transferring and managing family property. Limited Liability Companies. An LLC is created by filing with the State Corporation Commission, and offers hybrid advantages of a corporation and a partnership. Like a corporation, the LLC is a separate legal entity which shields its owners (known as “members”) from liabilities of the company. Like a partnership, however, the entity can be governed more simply by a written contract amongst the members (an operating agreement), and there is no double taxation associated with an LLC; the income tax consequences, gains and losses of the LLC are passed through to the individual members. The operating agreement of a family LLC is crafted to address a number of succession planning issues. By transferring property interests or ownership rights in the LLC, as opposed to deeding interests in real estate, one is in a position to make family members feel ownership rights in the property, without concern over their partition rights and creditors. LLC owners have no right to seek partition, and the operating agreement can be drawn to severely limit the remedies available to creditors of a member. Likewise, by restricting the right of a member to transfer membership rights, the LLC can be structured to avoid a situation where ownership passes to unwanted parties such as ex-spouses, parties unrelated by blood or marriage, or creditors. Gifting or transferring ownership interests in an LLC is much simpler and less expensive than deeding fractional interests in real estate. Governance and Decision Making. The LLC operating agreement should contain a structure for governance of the family property. Put differently, the operating agreement designates those persons in authority, sets forth the procedures for decision making, and includes requirements and limitations on such powers as sale, assessing costs to family members, cutting timber or apportioning popular vacation dates for property use. Some LLCs are managed by a simple democratic process. These member-managed LLCs submit all questions of control, sale of property, use and other decisions to a majority vote. For larger families, in which there are a number of members, the LLC can designate a board of managers to control the entity and the property it holds. Thus, for example, a 15 or more member family LLC might appoint 3 to 5 managers to handle decisions critical to ongoing enjoyment, maintenance and stewardship of family property. One manager appointed from each branch of a family makes for an equitable way to apportion control of the LLC. Still other LLCs employ a corporate governance model, with a board of directors, and officers such as a president, vice president, secretary and treasurer. Although a board of managers or president is commonly given day-to-day operational control, and makes decisions concerning maintenance schedules, dates when various members of the family can use family property, the leasing of farming rights and the like, many families require a supermajority vote of the members of an LLC for big decisions. So, for example, the decision to sell a family property, to cut timber, or to assess members of the LLC money for maintenance, big construction projects or other unusual expenses can be relegated to a 75% supermajority vote for approval by the LLC members. The flexibility of the laws governing operating agreements makes tailoring the LLC to a particular familys needs and goals possible. Estate and Gift Tax Planning. From an estate planning perspective, the LLC is advantageous as well. Mentioned above is the ease of transferring membership interests in an LLC as opposed to deeded property rights. In addition, gifts of membership interests in the LLC during life or at death can qualify for discounted valuation under estate and gift tax laws, allowing a donor/decedent to transfer larger interests in the LLC with fewer estate and gift tax consequences. Conclusion. An LLC created by family members provides a convenient and tax-advantaged method by which to own, control, transfer and preserve cherished family real estate. The entity protects family members from liabilities arising from ownership of family property, and the broad array of options available in structuring the governance and control of an LLC can be tailored to meet the needs of most families. —Gregory R. Davis