Published in Chamber Review - the Concord (NH) Chamber of Commerce's newsletter (July 2016)
As temperatures rise and days grow longer, many New Hampshire residents have begun opening vacation homes for use during the spring and summer months. Vacation homes often serve as the reunion grounds that bring families together. However, an uncertain future about what will happen to the vacation home after parents pass away and the next generation inherits the property can lead to stress, arguments and divisions between family members. In many families, siblings who will eventually inherit the vacation home earn disparate incomes. This discrepancy may lead to stress that one sibling will bear the financial burden of the property’s upkeep and arguments about what to do with the property.
Placing the property into a limited liability company (“LLC”) may help resolve these issues and preserve familial harmony. An LLC is governed by an operating agreement, which can set forth the rules of the vacation home’s use and economic responsibilities of each member of the LLC (i.e. the siblings). Documenting the use and financial expectations among siblings at the outset of ownership can prevent future disputes. An operating agreement can set forth the amount of time each sibling has sole access to the vacation home and describe the maintenance and upkeep responsibilities of each family member. The operating agreement can also be dynamic with built-in provisions that address changed circumstances and set rules about how to amend the agreement.
Disparate capabilities of contributing economically to the vacation home can be addressed in a number of ways, including tying the amount of time a member may use the vacation home to his or her financial contribution to the LLC. In addition, shares in the LLC are typically allocated based on the capital contributions of each member. Therefore, a member who contributes more capital to the LLC and pays a greater share of expenses will receive a greater portion of proceeds upon a sale of the vacation home.
Cash is not the only barometer for ownership percentages. A member with limited funds may devote additional time to the property’s maintenance in exchange for equal shares in the LLC. The operating agreement may also permit a member to rent the property to third parties during his or her designated period of use. This arrangement not only brings rental income into the LLC but also enables the members to take advantage of the liability protection that an LLC affords its members. Tax consequences may stem, however, from the fact that the LLC rents the property as opposed to holding it solely for family use.
Mechanisms can also be put in place to address disputes regarding when to sell the property. A sale of the vacation home may be conditioned upon the unanimous approval of the members. Alternatively, a buy-sell provision sets forth the process, price and terms of a member’s sale of shares in the LLC in the event that a sibling desires to sell the vacation home but the others do not. Finally, the operating agreement may limit transfer of shares to family members or provide existing members with a right of first refusal to purchase shares on the same terms offered by an outside party.
A conversation with tax counsel is warranted to ascertain the most appropriate tax structure for each particular situation given that LLCs have flexible tax elections and that there may be tax consequences if the LLC has business or rental income. Professional counsel is also recommended to help families address additional considerations such as real estate transfer taxes and maximal estate planning strategy. While these conversations may be uncomfortable, the benefits of planning ahead and structuring a plan to address an inevitable situation typically make an uncomfortable conversation well worthwhile.
Kara Dougherty is an attorney in the Corporate Department of McLane Middleton, Professional Association. She can be reached at (603) 628-1268 or at [email protected].