Distributing your assets among your descendants is always a tricky issue, especially if real estate is involved. For advice on how to proceed with a second home, we turn to Bruce Bell, an attorney in the Chicago office of Schoenberg Finkel Beederman Bell Cooler
Larry Light: Let’s say I have a vacation home that I want to leave to my three adult children, but I don’t know how. Do you have any suggestions?
Bruce Bell: There is no one way to leave a vacation home to children or other beneficiaries. A common approach is to create an entity such as a limited liability company, or LLC, to own the property. Corporations are generally not the entity of choice for the purpose of owning real estate.
Although it is relatively easy to transfer real estate and other assets into a corporation, there are often tax consequences when transferring such property out of corporations, such as to your children. With an LLC, on the other hand, once an LLC takes title to real estate, ownership can usually be transferred out of the LLC without tax consequences. LLCs, like corporations, provide asset protection because the owners, called “members” in the context of the LLC, are generally not personally liable for the obligations of the LLC.
Light: What happens next?
Bell: Deciding who the LLC owners are can be tricky. In many cases, it is not desirable for all children to become members. Often children have different interests and some, particularly those who do not live close to the property, may not want to be part of owning a holiday home.
If not all children are to be members, you, the parent, have an additional problem to deal with: are you going to pass on additional assets to the non-participating child, to compensate the child for not becoming an LLC owner?
Light: What if all of these LLC owners, namely the children, disagree on a home-related issue?
Bell: This is why you need a written governing document called an operating agreement. Although a majority decision may be the rule, you may want to allow for situations where unanimity is required. Decisions such as when to sell the home, make major improvements, and mortgage the property are often best made by unanimous vote.
Light: What if a child wants to leave the LLC, perhaps no longer wanting to be part of the vacation retreat?
Bell: A mechanism can be included in the operating agreement for a child to be bought out by the other children. It must specify the purchase price and the method of determining the price, whether by appraisal or otherwise. Also, the operating agreement should detail the method of payment, whether it is an upfront payment, deferred payments, and other issues.
Light: What if one of the children dies?
Bell: Options include allowing a child to pass their interest to beneficiaries, allowing forfeiture of the interest, or redeeming the interest from the estate.
Light: On a day-to-day basis, how does the LLC deal with issues such as who pays expenses and how much, and who can use the place and when?
Bell: Yes, there are property taxes, insurance, repairs and maintenance, and other operating expenses. The operating agreement should specify how payments should be made, and how and when children should contribute cash for these payments. In some cases, a parent funds the LLC with a significant amount of money to cover these expenses, either for a period of years or in some cases in perpetuity.
Also, the agreement may establish rules about who can use the house and when, perhaps on a schedule.
Light: The children might not follow the arrangement of the parents.
Bell: Many parents avoid the problem by simply leaving the legal interest in the home to the children and letting them create their own arrangement. But if it seems like the house is something the kids want to maintain for years to come, you might be better served setting up the property vehicle now, while you’re alive and able to do so.