A vacation home can be the setting for an extended family’s fondest memories. Whether it’s a cabin in the mountains or a cottage by a lake, this is a place for grown kids and young cousins to reunite and relax.
Vacation-home owners might imagine that these properties will be enjoyed by their descendants for decades to come—but that’s usually not what happens. Problems often start as soon as the following generation inherits and attempts to share ownership. Even if all the adult kids are well-meaning, they inevitably have divergent ideas about the care and use of the property. That leads to disagreements, ill will and, sooner than you might ever have expected, the property’s sale.
If you want your vacation property to be enjoyed by your family after you are gone and to be a positive force, it’s up to you to avoid the big mistakes that vacation-home owners typically make when they leave homes to the next generation…
Mistake: Using the wrong method to transfer the property to heirs. Many vacation-home owners sow the seeds of family discord by the legal means they use to hand down the properties…
Leaving a property in a will. This is very easy—but it’s a mistake if there is more than one child. Consider how hard it can be to agree with one’s own spouse about how and when to spend money maintaining and improving a home. Now consider how challenging this would become if, as happens when ownership is divvied up in a will, several siblings had to agree—siblings who might have very different budgets and priorities, plus their own spouses to answer to.
Leaving a property through a trust. This can be a reasonable option, but it, too, can lead to discord. Often some descendants become convinced that the descendant who was named trustee is taking unfair advantage of his/her power. And if someone other than a descendant is named trustee, all the heirs might bristle at their lack of control. In addition, using a trust may not provide adequate protection against the claims of your heirs’ creditors—and family ownership of the property might therefore be threatened.
Using a tenancy in common. This legal arrangement of ownership allows two or more people to hold shares in a property. But this is a terrible choice if your goal is to keep the property in the family. In most states, any of the “tenants” has the right to force the sale of the property, virtually guaranteeing that it won’t remain in the family long.
In most cases, the best route to leave a vacation home to your descendants is to transfer ownership to a limited liability company (LLC) set up for this purpose during your lifetime. With an LLC, you get to design an “operating agreement” that lays out descendants’ rights and obligations if they wish to continue owning shares of the property. Laying out these rules now saves your heirs from bickering over them later. An LLC can continue in perpetuity, making it simple for your descendants eventually to leave the property to their descendants…spelling out the rules if they decide to sell (more on this below)…and limiting your heirs’ exposure in any lawsuits related to the property.
Each “branch” of your family—that is, the families of each of your children—typically names one representative to the LLC’s “management council,” which functions like a corporate board of directors. This way, all feel that their voices are being heard, and disagreements can be settled through a preselected process such as a management council vote.
An estate-planning attorney might be able to set up an LLC of this sort for as little as $1,000, though costs could be several times that amount in high-cost areas or with complex arrangements. There also are certain tax-filing requirements for LLCs. If there is a mortgage on the property, the lender might block the transfer of ownership to the LLC, and owning a property through an LLC could interfere with your ability to deduct its mortgage interest. You can work through all these wrinkles with your attorney or accountant.
Mistake: Failing to restrict ownership to descendants. If you do not take steps to prevent it, one of your descendants could sell his share in your vacation property to someone outside the family…or lose control of his share in a divorce or lawsuit.
Better: Ask your attorney to include language in the LLC operating agreement (described above) stating that the only people eligible to be partial owners are “lineal descendants” of you and your spouse—this phrase means that only people who can trace their ancestry directly back to you are eligible. (It’s worth specifying that adopted descendants and/or stepchildren can become partial owners, too.)
Mistake: Failing to think through future sales prices. At some point, some of your heirs will want to sell their shares of the vacation property. If you do not plan for this, it could become a source of tremendous family conflict.
For the property to remain in your family, sellers must be restricted to selling to other family members—but that means relatives will be on opposite sides of the table with thousands of dollars at stake. Sellers want to get fair market value…while buyers argue that surrendering a share of a family property is different from selling on the open market. Often everyone ends up angry.
Better: Provide a specific formula for determining how much heirs receive when selling to other heirs. One good way to do this is to mandate that future generations should start with the property’s most recent municipal assessment…adjust that assessed value to reflect the actual property value, if necessary (in some locales, assessed value is 50% of fair market value, for example)…and then apply a discount rate and payment schedule of your choosing. Typically, this discount is between 25% and 50% and the payment period is five or 10 years. The higher the discount rate and the longer the payment period, the greater the odds that the property will remain in your family because selling becomes less attractive and buying becomes more attractive. Descendants typically are required to buy out those who decide to sell. Because of this obligation to buy, it is critical that the operating agreement provide a formula for establishing favorable purchase price and payment terms.
To prevent a situation where a well-off heir buys out the other heirs and then sells the house on the open market for a large profit, the rules can include a provision that if the property is sold outside the family within a certain time after an heir sells to another heir, the share-selling heir is to receive a certain percentage of what he/she would have received if the intrafamily sale had not occurred.
Mistake: Making descendants shoulder the full costs of ownership. Owning a vacation home with its property taxes, insurance premiums, utility bills and upkeep can be costly. These costs are among the most common reasons that descendants decide to sell.
Better: If you can afford to, set up an endowment fund to cover ownership costs. Go back through your records to determine your approximate annual costs, divide this figure by 0.03 and, if possible, put that amount in a low-risk mutual fund or some other investment that is likely to pay annual returns of at least 3%. This will require a very significant amount of money, however—it comes to $333,333 even with relatively modest annual expenses of $10,000. But, when feasible, it is a way to ensure that your descendants who have limited financial resources can continue to own a share in the property.
If you cannot afford this full endowment, put a smaller amount of money aside to pay ownership costs. This buys your heirs time to figure out whether they can afford to own the property.
Mistake: Establishing a schedule for use of the home rather than a flexible system for creating a schedule. Heirs won’t always want multifamily reunions at the house—they’ll want individual family time as well. But if you try to assign certain descendants certain weeks, as many benefactors have done, some heirs inevitably will feel that they’re getting the short end of the stick.
Better: The property’s operating agreement should divide the peak season into “use periods” of between one and three weeks and instruct heirs to take turns picking periods. Which heir gets first pick should rotate annually.
Mistake: Letting heirs be “half in.” An heir who uses the property only rarely might not want to have a full ownership share but might not want to sell his entire share either. In situations like this, it can be tempting to create “partial shares” or other complicated ownership distinctions. Don’t do it. Doing so will only open the door for other descendants to angle for their own special arrangements, forcing remaining heirs to buy up an ever-larger percentage of the property and pay a huge portion of the expenses.
Better: Give descendants just two options—in or out. An heir who wants to use the property only very rarely could be allowed to sell his share to another heir and then visit occasionally as a guest.