Jointly owning and sharing a vacation home is a great way for families to conveniently escape and unwind.
Ownership rules and regulations must be meticulously detailed and carefully planned to promote peaceful and harmonious enjoyment of the property, and to avoid the occasional (or more than the occasional) misunderstanding.
The form of ownership selected by the family member owners, along with the supporting written documentation, will define how all legal, financial, and administrative functions of the vacation home will operate, including:
- limiting the liability of the owners
- keeping tabs on associated income and expenses
- establishing management responsibilities and usage schedules
- transferring ownership interests
- estate and gift tax planning and administration
While there are a number of structural choices for family vacation home ownership—holding in a trust, structuring as a corporation, or titling as part of tenants in common or joint tenancy with the right of survivorship—the option that tends to be the most widely used by financially-savvy families is the Vacation Home LLC.
Once this structure is chosen, an Operating Agreement is drafted, which is the governing document for LLCs. This document then becomes the legal and financial rulebook and administrative roadmap wherein all pertinent terms are specifically defined for family member LLC owners.
1] Protection From Liability & Creditors
The LLC ownership structure significantly reduces the liability exposure of its members, including shielding LLC owners from litigation arising from:
- physical harm suffered by tenants or visitors of the vacation home
- judgments and liens levied against LLC owners by trade creditors hired by the LLC
- judgments awarded to opposing parties of LLC members for personal claims completely unrelated to the property
In addition to the substantial liability protection afforded by the LLC entity, it is vitally important for responsible home owners to supplement this protection with a generous amount of umbrella liability insurance coverage in order to properly and effectively protect the assets of the LLC members.
2] Management and Usage of the Vacation Home
A properly drafted LLC operating agreement puts everything in writing, and should include detailed provisions delineating the management responsibilities of its members (the LLC owners) specifying:
- the individuals who are permitted to access the property
- the specific times and dates each member is permitted to use the property
- the individuals who are authorized to make legally enforceable decisions, such as obtaining adequate insurance coverage and coordinating maintenance or repairs
- the appropriate manner in which overall management and ownership responsibilities may be passed from one LLC member to another
3] Financial Administration and Bookkeeping
An LLC is an independent legal entity which has its own bank account, with funds earmarked for property management and operating expenses. As a result, the expenses related to owning and operating the property—including mortgage payments, property taxes, repairs and maintenance, and substantial property improvements—can be divided among individual LLC members in amounts proportionate to their respective use of the home. Likewise, income generated from renting the property can also be distributed proportionally among the members.
4] Buy-Sell Provisions for Ownership Transfers
LLCs last forever, possessing what is often referred to as a “perpetual existence.” As such, the LLC operating agreement can include restrictions regarding how and to whom members may sell or transfer their property ownership shares (membership interests). The operating agreement can further dictate such items as:
- which individuals—other than immediate family—will be permitted to become an owner in the LLC
- in what scenarios former spouses of members can be barred from acquiring or maintaining ownership
- the required use of a certified appraiser to value the property for either potential sale or gifting and estate tax planning
Furthermore, the LLC structure allows members to be flexible when it comes to intra-family ownership transfers, since LLC membership interests are technically classified as the personal property of the associated LLC members. The transfer of those interests does not constitute the conveyance of real property owned by the LLC. Accordingly, intra-family transfers can be transacted without violating any anti-transfer clauses that may be instituted by lenders. These intra-family transfers will also not incur any real property transfer fees or taxes, and will not impact existing title insurance.
5] Estate & Gift Tax Planning
When a vacation home is in a different state (ancillary state) from that of the decedent’s primary residence (domiciliary state), the estate executor may be required to have the property probated. With a Vacation Home LLC, probate may be conveniently avoided in this scenario, preventing what could be a complex and costly probate proceeding. Additionally, when an LLC member dies, heirs will be given a “stepped-up basis”, which is an increase in cost basis of the property to its fair market value. This upward cost basis adjustment can considerably lower the subsequent capital gains tax owed upon the home’s eventual sale. What’s more, LLC interests are both restricted and fractionalized, meaning they result in minority and marketability discounts, which in turn lower appraisal valuations as well as estate and gift tax obligations.
Intelligent Families Use the Vacation Home LLC
Holding your vacation home in its own LLC presents a wealth of advantages. Unlike corporations, LLCs are relatively hassle-free to set up and maintain. And, most states allow the LLC form of ownership for personal items like a vacation home. Since every state and family has its own unique requirements, an experienced attorney should be retained to draft the appropriate operating agreement in accordance with the applicable state laws and family desires.
This article is not tax, legal, or other professional advice and cannot be relied upon for any purpose without consultation and advice from a retained professional.
As one of the most knowledgeable and well-connected tax & accounting professionals in the world, Harvey Bezozi's mission as a CPA and CFP ® is to provide concierge-level work product and service, along with seamless communication, high energy, and a super-positive attitude. Located in Boca Raton, Florida, Bezozi has been in business since 1994, and serves clients in all 50 states and internationally. More information can be found at YourFinancialWizard.com
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