Retzner: The family vacation home: harmony or chaos?

Retzner

By Rodney S. Retzner

For many families, harmony and closeness are achieved through a family getaway, often to a second home, remote enough to get away from the constant communication (maybe outside cell phone range), but easy enough to get to for a long weekend or a holiday. A lake house, cottage in Michigan, or a condo in Florida are all havens for the family to create memories for a lifetime. Because of these great times and memories, families want to pass on the tradition and keep the vacation home in the family for the future generations. In most instances, vacation homes achieve the goal of family harmony. After the parents pass away, however, that family harmony can quickly turn to chaos.

Vacation homes are simple real estate. As real estate passes through generations, it can become a chaos of partial tenant-in-common interests, with fractional interests divided into smaller and smaller shares. Fractional interests in real estate, regardless of size, have rights to force partition and sale. Moreover, as the number of owners increases, the number of “votes” on what happens to the real estate increases as well, and those votes are not weighted based upon the interest in the property. This can become the very definition of chaos.

Various owners, all of different financial means, will likely not agree with respect to the level of maintenance to be performed on the vacation home, who gets to use the property when, and the variety of other decisions needed. The thought that “we’ll just figure it out” or “we’ll get along and don’t worry about it” will not work.

Putting the vacation home in a trust is one option which has viability. That trust also needs an adequate amount of cash for an endowment fund for maintenance items and upkeep of the property. Strict boundaries also need to be established to determine the mechanisms for how the property is to be used and by which family members and when. The trust should also contemplate the possibility of renting the property to pay for upkeep if the assets of the trust are not enough to keep up with expenses. Properly structured, a trust of this nature can last for generations. As the family continues to grow, however, there is the need for an exit strategy with respect to the trust, so there needs to be a mechanism by which the property is sold if the trust can no longer afford to maintain the property or if the family members no longer use the property.

An even better option is to have a company formed to hold the vacation real estate. During the parents’ lifetimes, they own the interest in the LLC and continue to pay the expenses. The company would be a “pass-through” entity for tax purposes (and if a single member LLC, can even be a disregarded entity with no separate tax filing). The real benefit of the company format comes when the children inherit their interest in the company rather than their interest directly in the real estate itself. Three children each owning an equal interest have the ability to vote or out vote one another, depending on the actual percentage interest they hold. If two of the three children now agree that the roof needs to be fixed, the roof gets fixed rather than requiring a unanimous decision by all fractional interest holders. As interest passes from one generation to the next, each subsequent holder of interest votes his percentage interest rather than having the right to force action on the whole. Capital calls can also be installed to remedy any unfairness in the payment of expenses or upkeep. Transfer restrictions can be established to protect against divorce or other transfers of interest in the family vacation home. If a capital call for maintenance is required and not all members can afford to pay, the agreement can provide for a change in interest percentage based on who pays and who does not. Finally, the operating agreement can discuss the exit strategy as to when to sell and to whom as well as the potential for members to buy one another out and establish the price for such transactions and the mechanisms by which such transactions occur and who can participate.

In both the trust and the company situation, there needs to be a clear mechanism by which use of the vacation home is determined. No one will be happy when they show up at the vacation home for the Fourth of July and find the bedrooms already filled with cousins and the boat already out on the lake. The mechanism by which the family decides the use of the property needs to be clear. Typically, the oldest generation will go first in picking the weeks or weekends in which they want to use the property, then the next generation, and so on until all the dates are used. This can be at an annual meeting over the holidays. As interest in the property passes to future generations, the percentage of use available then also reduces based on the percentage ownership. Compare this to the tenant-in-common interest where anyone who holds an interest has the right to use of the whole at any time. Special situations involving holiday weekends and peak times of use can also be decided in advance by lot or by rotation among family lines. The key is that these provisions for determining the use need to be put in place as part of the entity which holds the property.

Family vacation homes have great potential for family harmony and time together. They also have great potential to destroy family harmony. By providing clear direction as to maintenance, preservation and use, however, that family harmony can be preserved and the chaos avoided.•

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Rodney S. Retzner is a partner and chair of the estate planning and personal services practice group at Krieg DeVault LLP. He concentrates his practice in the areas of estate and business succession planning, estate and trust administration, and estate and trust litigation. The opinions expressed are those of the author.