Private Client Services Update – Succession Planning for Family Vacation Properties
By William L. Holt, Estate, Trust & Wealth Transfer
Whether it’s a beach cottage, a ski cabin in the mountains, a lake house, or a family farm, for many of us, family vacation properties have been the source of treasured memories for many years. Surprisingly though, when it comes to estate planning, thoughtful arrangements for the succession of family vacation properties are not always a priority. Often times, family vacation properties are left to pass along with the bulk of other assets, possibly with the hope and understanding that the vacation property would remain in the family, but without any specific planning. Unfortunately, all too often once the surviving family members learn the true extent of the accompanying maintenance and expense required, these cherished vacation properties can become some of the most controversial assets for beneficiaries to share due to the differing interests and personal circumstances of each beneficiary. So, what can owners do during their lifetimes to ensure their hard-earned and beloved vacation properties are preserved and well-managed for future generations to enjoy? The establishment of a family limited liability company (LLC) during the owner’s lifetime has become the preferable ownership model for family vacation properties because of the structure and flexibility offered as discussed below.
- Perpetual Existence and Continuity of Ownership. One of the biggest problems resulting from vacation properties owned through traditional forms of joint ownership (such as tenancy in common or joint tenancy with the right of survivorship) is that the property remains open to the risk of an owner seeking to partition the property or attempting to force a sale of the property to effect a buy-out of such owner’s share. However, by using an LLC to own property, family members will receive an ownership interest in the LLC, as opposed to any ownership in the property itself, so the ability to seek partition is eliminated. The original owners, with the input of the next generation(s) of family members, should establish a thoughtful framework for continued ownership, maintenance, and management of the property through a detailed operating agreement.
- Structured Succession of Ownership and Control. Ideally, the LLC should be established by the original owners of the family vacation property with input from the family members on the terms of the operating agreement. After forming the LLC, the ownership interests can be transferred to the succeeding family members during the original owners’ lifetime (over a period of time if necessary to take advantage of gift tax annual exclusions and minority and marketability discounts), or after the death of the survivor of the original owners. The original owners can hand-select the family members they want to become members of the LLC and can define the structure for how ownership is to pass through successive generations. For example, the owner could give one ownership share to each of the owner’s children, and allow each child to appoint, by gift or will, the successor of his or her share. There are endless possibilities to fit each specific family situation.
- Separate Management & Ownership. Because ownership and management of an LLC can be separate, the original owner(s) can continue to manage the property throughout their lifetimes, if desired. Ownership interests in the LLC can be transferred to the younger generation during the life of the senior generation or upon the death of the senior generation. Successor managers can be named upon creation of the LLC or the procedure for naming such successor(s) at a later time may be provided in the operating agreement. Depending on the specific situation, it may be appropriate for several local family members to share management responsibilities for the property, or in other cases, an independent third-party manager may be preferred. These options are all provided by the LLC structure.
- Liability Protection for Owners. Proper formation, use, and maintenance of the LLC will limit the individual owners’ exposure to lawsuits by users or creditors of the family vacation property.
- Restrictions on Transfer of Ownership Interests. Many owners’ main objective is to keep their vacation property in the family. Accordingly, LLC operating agreements can provide any such restrictions desired by the owner, including the ability to prohibit transfers to anyone other than direct lineal descendants of the original owners or to provide family members the first right of refusal before the property can be transferred to a non-family member. Additionally, an LLC operating agreement could also contain a buy-sell provision with a predetermined sales price, valuation method, or payment terms to govern in the event that a member/owner needs to sell his or her share.
- Budgeting Shared Expenses. The operating agreement should provide a budgeting procedure for the expenses of owning, maintaining, and improving the property. Generally, if the property does not generate enough income to pay the annual expenses, then such expenses can be divided among the members of the LLC. If a member does not pay his or her contribution, the operating agreement can provide for penalties such as charging interest on any unpaid contributions, restricting the use of the property, and/or proportional relinquishment of the defaulting member’s ownership to the remaining non-defaulting LLC members. Additionally, in some circumstances, the original owner may wish to establish an endowment fund to cover maintenance and ownership expenses for the property, in order to lessen the financial burden on future generations of owners.
- Scheduling Shared Use of the Property. Another very important component of an operating agreement should provide for an orderly system of scheduling shared use of the property tailored to the unique goals of the family, with an equitable method for assigning the most desirable dates, such as peak seasons, holidays, etc. Consideration should also be given to whether or not the family will allow the property to be rented or used by non-family members, and the applicable rates, and rules for such use.
- Potential Tax Benefits. If ownership interests in the LLC are transferred from the original owner during the owner’s lifetime, such transfers are subject to federal gift tax law. However, by using the gift tax annual exclusion amount (currently $13,000 per donee from each donor) and lifetime exclusion amount (currently $1 million), depending on the value of the property, one may be able to avoid paying any gift tax. Additionally, the value of the LLC membership interests may be able to be discounted based on minority ownership and lack of marketability. This can reduce the value of any interest retained by the original owners, thus reducing the value of their estate for estate tax purposes.
With a little time and attention spent establishing a framework, a family LLC can provide the ideal structure for a smooth transition of family vacation property throughout successive generations of ownership.
William L. Holt is an attorney at Kaufman & Canoles, where his practice focuses on estate planning, business law, and real estate matters. Will is a member of the firm’s Private Client Services Group and the Real Estate Strategies Group. Will is a graduate of the College of William & Mary’s Marshall-Wythe School of Law. He works in the firm’s Williamsburg office and can be reached at (757) 259.3885 or email@example.com.
The contents of this publication are intended for general information only and should not be construed as legal advice or a legal opinion on specific facts and circumstances. Copyright 2023.