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September 2008 Estate Planning and the Transfer of Vacation Property How should valuable real estate be transferred to adult children without the risk of an eventual family blow-up? Most estate planners well-versed in strategies to transfer a family business from the owner to a successor-child while providing an equitable share of the estate to the non-business children. In these situations, an overriding principle is that the business goes to those involved, and we don’t create the risk of future family discord by giving business interests to uninvolved heirs. But what about valuable vacation property? Mom and Dad have that beachfront home or mountain cabin that the entire family enjoys and cherishes. How should that valuable asset be transferred to, for instance, three children without the risk of a financial or family blow-up down the road? In this article we will discuss three options that individuals in this situation might find useful:
The “No Plan” Plan. This strategy treats the vacation home as any other residual asset: All children share equally. Assuming that they agree to retain the asset, each of the three children would own an undivided one-third title to the property and would share equally in the overhead (property taxes, maintenance, insurance, utilities, etc.). Presumably, they work out a plan to share its use and can agree on the big decisions of capital improvements and major repairs. Things work well – at least in the short run. Ten or 15 years later the situation has evolved. One child is a very active user and has probably assumed most of the decision-making and, perhaps, the financial cost of repairs and other discretionary expenditures. Another child is an occasional user and contributor to the overhead. The third child never uses the property, has become increasingly resentful of the asset that belongs to the siblings, and has a spouse who regularly points out that they own a multi-million dollar vacation property that is a financial drain from which they get no benefit. The siblings may work it out without the need for expensive appraisals and legal costs, but the process has the potential for becoming contentious. The Entity Approach. Under this strategy, Mom and Dad transfer the vacation property to a partnership or similar entity, such as an LLC. The children do not inherit a direct interest in the real estate; rather, they receive an interest in a partnership that has a governing document. The key difference is that each child’s ownership is subject to the terms of that partnership agreement. This agreement can cover annual operating issues, such as an annual contribution to provide funds for taxes and maintenance. It may also designate one or more children to serve as manager to handle the day-to-day decisions. Most important, the agreement can provide buy-out terms. For example, the agreement might require that the sibling/partners secure two appraisals, average those appraisals, apply a small discount, and structure payments to a departing owner over a specified period of time at a reasonable interest rate. These buy-out terms can eliminate much of the negotiating tension among the siblings and spare the remaining owners from an undue financial burden. This plan is better than the no-plan plan, but there may still be some tension to the timing and payout arrangement if one child presses for a sale at a time that is difficult for the remaining owners. The No-Sell Solution. Following the deaths of Mom and Dad, the vacation property goes into a trust arrangement for the benefit of the children. In addition to placing the vacation property into the trust, an additional sum of money is transferred. This capital, when invested, is to provide a source of funds to cover the taxes and repairs and, perhaps, even occasional major improvements, so that the overhead of maintaining the property is not a burden on any of the children, regardless of their financial circumstance. The operating decisions rest with independent trustees (such as a trust department or other family members). The children will advise the trustee regarding necessary improvements and maintenance, but independent judgment is in control. The key difference in this plan occurs when a child wishes to cash out, potentially tripping that contentious buyer-seller relationship. The trust specifically prohibits any sale of an interest, although it might permit a like-kind exchange into a similar vacation property. In fact, the children and their heirs are beneficiaries only to the extent of the use of the property. Ultimately, if the users all decide to sell, the sale proceeds are mandatorily bequeathed to a charity. This unusual approach of any sale proceeds directed to charity assures that no child can convert his or her share of the vacation property into other wealth. The vacation property has only one benefit: its ongoing use and enjoyment by family members and their descendents. Ultimately, when the use diminishes down the road, the children will not be in an adversarial financial position. There will be no financial incentive to cash out, which likely encourages continued use and enjoyment within the family for many years. Based in Mesa, Arizona, and serving closely held businesses in the East Valley, the Phoenix area and throughout Arizona, Schmidt Westergard & Company, PLLC, is an independent full-service tax, audit, accounting and business advisory firm focusing on the middle market. |