Dividing your assets among your offspring is always a fraught question, especially if real estate is at issue. For tips on how to do this with a second home, we turn to Bruce Bell, an attorney at the Chicago office of Schoenberg Finkel Beederman Bell Glazer
Larry Light: let’s say I have a vacation home that I want to leave to my three grown children, but I am not sure how to do so. Do you have any suggestions?
Bruce Bell: There is no one way to leave a vacation home to children or other beneficiaries. One common approach is to create an entity such as a limited liability company, or LLC, to become the owner of the property. Corporations are typically not the entity of choice for purposes of holding real estate.
While it is relatively easy to transfer real estate and other assets into a corporation, there are often tax consequences in transferring such property out of corporations, like to your children. With an LLC, on the other hand, once an LLC takes title to the real estate, the property can usually be transferred out of the LLC without tax consequences. LLCs, like corporate entities, offer asset protection, as the owners, called “members” in the LLC context, are not generally speaking personally responsible for LLC obligations.
light: What happens next?
bell: Deciding who the LLC owners can be tricky. In many cases, it is not desirable for all the children to become members. Often, children have different interests and some, particularly those who do not live near the property, may not want to be part of vacation home ownership.
If not all the children are to be members, you the parent have an additional issue to address: Will you pass additional assets to the non-participating child, to compensate the child for not becoming a LLC owner?
light: What happens if all these LLC owners, namely the children, disagree about some issue related to the home?
bell: That’s 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, whether to make significant improvements and whether to mortgage the property are often best decided by a unanimous vote.
light: What happens if one child wants to quit the LLC, perhaps no longer wishing to be a 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 should specify the purchase price, and the methodology for determining the price, whether by appraisal or otherwise. Also, the operating agreement should detail the method of payment, be it cash up front, deferred payments and other issues.
light: What if one of the kids dies?
bell: Options include permitting a child to pass his or her interest to beneficiaries, allowing the interest to be forfeited or repurchasing the interest from the estate.
light: Day to day, how does the LLC sort out matters like who pays expenses and how much, and who gets to use the place and when?
bell: Yes, there are real estate taxes, insurance, repairs and maintenance and other operating expenses. The operating agreement must specify how payments are to be made, and how and when the children must contribute cash for such payments. In some cases, a parent funds the LLC with a meaningful amount of cash to cover these expenses, either for a period of years or in some cases in perpetuity.
Also, the agreement may lay down rules for who gets to use the home and when, perhaps by a schedule.
light: The kids might not cotton to the parents’ arrangement.
bell: Many parents avoid the issue by simply leaving the legal interest in the home to the children and letting them create their own arrangement. But if it looks like the home may be something the children want to maintain for years to come, you may be better served by putting the ownership vehicle in place now, while you are alive and able to do so.