Cottage Trusts – Is this the answer for your family? Part 1
Northern Michigan is a beautiful place – lots of waterfront homes and vacation retreats. Many families look for ways to keep their properties in the family to benefit their children and grandchildren.
Is a Cottage Trust right for your family?
First, vacation properties are often placed into a family L.L.C. (Limited Liability Company) instead of an irrevocable trust. The L.L.C. will have an Operating Agreement which will bind the future members and it can set out the rules of ownership.
If the property has been in the family for a long period of time, it may not be a good idea to transfer the real property during the lifetime of the owners as the property taxes would uncap – leaving the current owners with a higher tax burden than they now have.
If the property is transferred to an L.L.C. upon the death of the owners, the property taxes will, however, uncap upon the transfer to the L.L.C. If the property were left instead directly to the children as joint tenants, the property taxes would not uncap. This often is not practical for families with more than two or three children. It may be better to forego property tax savings in order to have the structure necessary to guide the ownership of the property.
What are some concerns and discussion points that should be addressed prior to heading down this road?
Management of the Cottage:
Will the Cottage LLC be member managed, thereby giving each child equal input into the use and upkeep of the property? Or will it be manager managed, making one of the children the ultimate manager?
If your children have difficulty getting along, it may be unrealistic to believe that they will do so after you are no longer here to mediate. Property ownership and management can be difficult when it is among small numbers of people who get along well. It may be impossible with a larger number of people who are always at odds.
Should the management of the Cottage be broken into different jobs such as Operations/Maintenance Manager, Record Keeping/Scheduling Manager and Financial Manager? This would give different family members the opportunity to be involved in a meaningful way in the management of the cottage while separating the tasks so that no one individual has all of the power or all of the work.
How will the annual cost of maintaining the cottage be handled? There are many costs associated with a vacation property: Property Taxes, Insurance, Utilities, Maintenance and Repairs. Will this be paid for by a stipend that you leave for such purposes? Or are the children expected to each shoulder his or her pro-rata share?
If your children are expected to pay for the maintenance of the cottage, consider whether they all can afford this cost going forward. Have you asked them whether they want the cottage to be kept in the family – especially if they are going to be paying for it on an annual basis?
How will the issue of capital improvements be handled? Again it is important to consider how such repairs and improvements will be paid for. Homes need new roofs, new furnaces, etc. Another consideration will be the mechanism of deciding when those repairs and/or improvements are necessary. One child may want to be proactive while another may want to wait until the roof leaks or the furnace quits prior to making the repair.
What happens if one of the members either cannot or will not contribute his or her annual share? If there are costs to be borne by the children and one does not participate financially, should he or she lose some of the ownership interest in the LLC?
Who will be responsible for writing the checks and paying the bills and taxes? Even if the mechanism is in place to have sufficient money available – someone needs to be in charge of making certain that these bills are paid.