If you co-own a family vacation home with members of your family, owning your vacation home within a limited liability company (LLC) instead of a trust or a corporation (which are also options) is one of the most effective strategies for helping you to avoid future legal and financial ramifications. Here are four ways in which establishing an LLC proves advantageous:
1. Protecting Your Asset – Holding your vacation home in an LLC offers the dual benefits of giving you the tax planning flexibility you would enjoy if you set it up as a partnership alongside the protection you’d receive if it had been set up as a corporation. One of the most important reasons to opt in favor of an LLC for this purpose is to protect both your vacation home and your assets outside of the LLC from any lawsuits that might arise at the property from visitors who may have gotten injured, on site.
In most states, if the worst did come to pass and someone did get injured at the property, an LLC structure will prevent the claimant from going after anything outside of the LLC-owned vacation home and the investment the family’s made in it. In other words, a claimant would not be able to extend the suit to the individual owners and their personal assets.
Additionally, if one of the family member owners of the vacation property is being sought by creditors in a matter independent of the vacation home property, an LLC excludes the property from the creditors’ reach. In order to execute this strategy, you will have to parse out shares in the LLC to all the various family members you wish to take ownership of managing the property, paying its costs, or taking care of improvements and any repairs that are needed, when establishing the LLC. You’ll still want to be certain that you take out added liability insurance for the property. Again, since state laws vary, it’s always wise to check with your trusted advisor when setting up a vacation home LLC.
2. Streamlining Property Management – A sound LLC structuring plan begins with a comprehensive vacation home LLC operating agreement. The agreement details what each family member’s responsibility and rights will be. Items covered include:
- Who will be permitted to make overarching decisions about the property (including transitioning it to another generation);
- What purposes the home can and cannot be used for;
- Who (both in the family and outside of it) is allowed to use the home and on what schedule;
- How rental income will be handled;
- Which family members will be responsible for certain costs associated with the property (such as insurance fees, mortgage payments, and repairs); and
- Who will attend to cleaning the property, making home improvements, and arranging for repairs.
Having an operating agreement spelled out in writing as thoroughly as possible can help circumvent family disagreements, should they arise.
3. Ownership Restrictions and Transfers – LLCs have what’s known as a “perpetual existence” which allows the structure to remain in place, in perpetuity. This helps prevent the unwanted selling off or transferring of all or portions of the vacation home further down the line, in keeping with the original vision of the vacation home LLC structure at the time it was established. Transfer restrictions can be built directly into the operating agreement to ensure that the home stays in the family.
One such example would be to write into the agreement restrictions on ownership by nonfamily members or those that would preclude ex-spouses from owning a piece of the property, in the future. Transfers of interest should also be addressed, upfront. One common approach is to require or allow the LLC or other members to purchase the interest of a member who is divorcing, filing for bankruptcy, or attempting to transfer his or her interest outside the family. The agreement might also provide for a professional appraisal of the interest to determine the price or give the other members a right of first refusal.
4. Estate and Gift Tax Planning Benefits – When the owner of a vacation home that’s located in a state other than the one the owner lives in, passes away, protracted probate proceedings can be avoided if the property has been set up as an LLC. In addition, upon the death of the owner, the vacation home LLC heirs will receive a step up in cost basis to the current fair market value. This vastly reduces the capital gains tax that will come due upon the property’s sale and can reduce your estate and gift taxes, in general.
A vacation home LLC isn’t the only way to own and share a family property, but its combination of limited liability, asset protection, and management flexibility makes it a structure of choice for many. To see if an LLC is the right path for you and your family to travel in, contact your Untracht Early advisor to learn more.