With a family-owned property, the rules can get complicated. Here’s what you need to know.
Q: Eight members, cousins and siblings, currently share ownership in a summer cottage in Maine. Our current rules have worked fine for over 80 years but as the family ownership expands, things will ultimately get more difficult. We are considering drawing up an LLC or some type of trust. I am concerned an LLC would have a lot of ongoing expenses. What would you recommend?
A: The underlying structure is less important than the understanding the family members have in how and when to use the cottage in Maine. The question we’d have for you is whether you know who the exact owners are and how their ownership held.
We have a suspicion that the 8 family members each own an ⅛ interest in the cottage and as each family member dies, his or her interest is divided among his or her heirs. Yes, that system can get quite complicated and can lead to ownership problems. But if you have a good understanding of what rights each owner has and what each owner’s obligations are, you can then decide what to do with the ownership structure.
So, on the one side you have the rules, responsibilities and obligations of all owners and on the other side you have the actual way you own the property. On the rules, responsibilities and obligations, you need to set that down on paper so that everybody has a clear understanding. While you may all own an ⅛ interest in the home, you also need a mechanism to vote to decide how things get done, who’s running the cottage, who pays for what, and who has the ultimate decision making power, etc.
All these decisions can cause friction in families but if the rules are written down, then everybody can understand where things stand. You also need a buyout clause so that if there is a disgruntled family member, that family member can sell his interest at a valuation that’s decided by a pre-determined mechanism, and the rest of the family members can buy the disgruntled family member’s interest in the cottage.
In the real estate investment world, a limited liability company (or LLC) might work well for you. Each family could own an ⅛ interest in the company units of the LLC and each family would decide how those interests would get passed down from one generation to the other. Ultimately, you will end up with the same problems as the ownership interests are diluted and more and more people are involved.
LLCs do have a cost to set up and have annual fees as well to maintain and you may also have IRS tax returns to file. We’d probably suggest that you talk to an attorney in your area to help sort through your ownership issues and help you make the right decision for all of you.
We tend to favor the idea of setting up a living trust to hold the ownership of the cottage. Living trusts have a one-time setup fee and usually don’t have annual fees due to the state, you may encounter federal income tax issues with LLCs and living trusts, but the transfer of ownership from the families to the LLC might trigger the most issues for federal income tax purposes.
Since you own the cottage in your names, if you “sell” or transfer your interests to the LLC, that transfer may be a sale. If it is considered a sale by the IRS, you might have to pay taxes on any appreciation the property has had. On the other hand, if you transfer your ownership interests to a living trust or other like document, you might avoid the issue of the transfer being considered a sale and avoid having federal income tax issues at this time.
So for tax reasons, setting forth the rules of ownership and other issues relating to owning the property, you should talk to an attorney or estate planner to go over your situation and make the best decision for all of you. We hope you all can agree and make a unanimous decision.