Planning For Your Family Cabin With The Limited Liability Company
THE COUNSELOR
Volume 3 • Issue 10 • November 2013
The Counselor is a monthly newsletter of Hallock & Hallock dedicated to providing useful information on estate planning, business succession planning and charitable planning issues. This month's issue will discuss protecting a family vacation property. If you are interested in learning more about the ideas discussed in this newsletter please contact us for an initial consultation.
Family cabins can be unique and special places for families. They are often full of wonderful memories and experiences, and are places that family members are emotionally attached to. Because of this attachment, many parents want to keep their family cabin in the hands of the family to benefit future generations. So whether your family owns a cabin in West Yellowstone, a lake front house in South Lake Tahoe, or a beach house in La Jolla, a family vacation property is a sizeable asset that needs planning in order to protect it for your children and grandchildren.
Why is Planning Necessary?
Many people assume that the only planning they need to do to keep their family cabin in the hands of the family is to give it to their children or grandchildren. Unfortunately, it is not that simple and there are a number of issues that any person or couple needs to address when dealing with the transfer of a family cabin.
Taxation
First, there are a myriad of tax issues to prepare for. Any gifts made during life are subject to a yearly gift tax exclusion of up to $14,000 per person. This means that you can give each of your children a gift of $14,000 each year ($28,000 for a married couple) without being taxed at the gift tax rate of 40%. The downside to this type of gifting is that the recipient of the property takes “carry-over basis” or the same basis as the donor. In short, this means that when the recipient of the property sells the property they will have to pay the same amount of capital gains tax as the donors would have had to pay had they sold it themselves. This is usually an undesirable consequence, but one that can be remedied by transferring the property at death which gives a recipient of gifted property a “step-up in basis.” This means that the recipient’s basis in the property is the fair market value of the property at the time of the death of the donor. In short, it means that if the recipient sells the property he will only be taxed on any gain made that is above the fair market value of the property at the time of the death of the donor.
Conflict and Dispute
Second, what many people fail to consider is the serious and often devastating consequences that can be caused by conflicts or disputes within the family. Many families have conflicts or disputes so rarely that parents don’t see the need to plan for this contingency. However, many families have never encountered anything remotely similar to the gifting or sale of a family cabin and the sad fact is that conflicts and disputes are not a rarity when it comes to inheritances. Therefore, it is vital not only to the survival of the cabin, but for the survival of healthy and loving relationships among your children. Conflicts and disputes can arise for a number of reasons. Some children might be counting on the cash value of the cabin to help pay for debts or future expenses. Some children, like a stepson or a daughter-in-law, might prefer the cash value of their share since they do not have a deep emotional tie to the property. Others might prefer the cash value because they live far away from the cabin and are rarely, if ever, able to use it. Situations similar to these set the stage for conflict and insufficient planning could lead to a forced sale of the family cabin and/or severed family relationships.
As an example, let’s say that you have a family cabin near Bear Lake and decide to leave it to your four children when you pass away. Three of your children love to use the cabin and are happy to maintain it, but one child lives on the east coast and doesn’t really care about the cabin. He and his family have no real attachment to the cabin and after a few years, he decides he can't afford his share of the expenses and doesn't want to own the cabin anymore. He would rather have the cash value of his share in the cabin to pay for the mortgage on his house or his children’s college tuition. He asks his siblings to buy him out, but they don’t have the money. They offer him what they can, but it's far less than the actual value of his share. They hate the thought of selling the cabin that they love and think their brother should stop being selfish and just let things stay as they are.
So what now? If there is no planning in place and the unhappy brother is determined to get his money out, he can force a sale of the property even though he only owns a 1/4th share. A forced sale not only means the cabin is gone, but it could also mean that family harmony is deeply damaged. To avoid potential problems like this, planning for the transfer of your family cabin is vital.
Solution: The Limited Liability Company
The first step to making any preparations for a family cabin is to have a family council to discuss what you and your children (and potentially grandchildren) would like to see happen to the family cabin. Don’t just assume that you all want the same thing because you might be surprised to learn that not everyone agrees on what should be done. During this meeting you should create a written “Master Plan” which lays out your collective desires concerning the cabin. Once you have done this and (hopefully) decided to preserve the family cabin, then you can begin to plan how to do so.
There are a handful of ways to protect a family cabin, but one effective method is by organizing a Limited Liability Company (LLC) to own the property. An LLC is a relatively new form of business organization that provides the limited liability features of a corporation and the tax efficiencies and operational flexibility of a partnership. Protecting a family cabin in an LLC creates a few distinct benefits:
Asset Protection. A properly managed LLC has the potential to protect assets by protecting the owners from the creditors of the LLC and by protecting the LLC from the creditors of the owners. This can be a huge benefit for anyone that has a child who struggles with their finances.
Control and Ownership. An LLC has the ability to give control of the LLC to a minority or majority owner, allowing a parent to retain control even after transferring much of their interest in the LLC to their children. An LLC can also regulate the number of people that can be owners and therefore avoid the problem of having a large number of owners with small fractional interests in the LLC.
Management. Management of an LLC can be governed by an operating agreement. These operating agreements dictate the rights and obligations of the LLC owners and can be written to address almost any potential problem, dispute, or event that might arise during the lifetime of the LLC. The agreement can address issues such as: use of the cabin, management of the cabin, payment of maintenance and other expenses, resolution of disputes, valid transfers of LLC interests, who can be an LLC owner, and what happens in the event of an owner’s divorce, death, or bankruptcy.
Tax Benefits. Transfer of an interest in an LLC provides distinct tax advantages over a transfer of the assets which an LLC holds. Transfers in LLC interests are given discounts of anywhere from 20% to 45% of the value of the underlying assets. For example, if you had a cabin worth $1,000,000 and transferred ¼ of it to your son then his interest would be worth $250,000. However, if you transferred a ¼ interest in an LLC that owned the same cabin worth $1,000,000 your son’s interest in the LLC would be worth anywhere from $137,500 to $200,000 depending on the amount of the discount. Thus, allowing you to gift over more property at a lower price.
Using an LLC is a great tool, but it does not come without its challenges. In order for an LLC to be effective, the owners need to be willing to observe the formalities and rules of the LLC. It also requires that one or more of the owners take on the responsibility of manager. As such, LLCs require some effort and dedication, but if you and your family are willing to put in the time necessary then it is not only a viable option, but an extremely flexible and efficient method for protecting your family cabin.
Conclusion
In conclusion, if your family cabin is something that you and your children want to preserve for future generations, then appropriate planning is needed. Creating a family cabin LLC is not the only way to protect your family’s vacation property, but it is one very useful way to do so. It can provide for asset protection, direction in managing and controlling the property, and tax benefits for as long as the LLC is in existence. With that said, the key to protecting your property is to take the time to plan and find the tool that works best for you and your family’s specific needs so that your cherished family cabin stays in the family for generations to come.
This Newsletter is for informational purposes only and not for the purpose of providing legal advice. You should contact an attorney to obtain advice with respect to any particular issue or problem. Nothing herein creates an attorney-client relationship between Hallock & Hallock and the reader.