By Harry S. Margolis
An old friend recently got in touch regarding his family's vacation home on an island off the Maine coast. He and his three sisters inherited the house from their parents and now one of them wants to be bought out. The other two can't afford to buy her out, but they don't want to lose the house which has sentimental value to them and is still the place their families come for vacation every year.
This situation raises many of the questions that need to be asked and answered when planning for a vacation home, whether by parents or by the next generation when they inherit the house. In this case, the family in fact created a trust that answers many of the important questions, but is a bit ambiguous about what would happen if one or more children wanted to opt out.
Here are seven questions it's important to answer for your vacation home:
- Who will manage the property? In my friend's case, two of the siblings are named as trustees to manage the property on behalf of the family. The trust says they may not receive any fees for service.
- How will use of the property be determined? In my friend's case, each child is entitled to two weeks per year, to be determined during the first two months of each calendar year. Once these periods are claimed, the trustees are expected to do their best to rent the property out if possible, with the children having additional access on a first come, first served basis for any time not previously claimed or rented out. What if a family member chooses not to use her allotted time; should she be able to rent the property out and collect the net rent herself?
- How will expenses be paid? In this case, by rental income to the extent possible, but each child is expected to make up his or her pro rata share of any shortfall. In some cases, parents will leave money in trust for house expenses. This can help a lot, though at some point such funds are likely to run out.
- Who will decide on capital expenses, whether maintenance—a new roof or rebuilding the decaying dock—or improvements—adding a dormer or solar panels? In most cases, the individuals managing the property should be empowered to make all maintenance decisions, but improvements should be agreed on by all the siblings. Of course, deciding what's maintenance and what's an improvement can sometimes get sticky.
- How long should the house stay in the family? Some families limit the longevity of co-ownership to a specific number of years, perhaps 10 or 20 years after the death of the longer surviving parent, while others provide that property stays in trust for the life of the longest surviving child, or even indefinitely. In my friend's case, the trust is to last 15 years with the property then to be sold and the proceeds distributed pro rata.
- What if one of the children wants to be bought out, as in my friend's case? There's no right or wrong answer, but clarity is important. Parents creating a trust can decide that no one can cash out ever, or for a period of time. It's easier that they impose any such restriction, since then it simply has to be accepted by the children. They can provide that anyone wanting to cash out must take a discount on his share of the fair market value in order to make it easier for the family to keep the property. The trust or family agreement can provide that if a certain percentage of the siblings want out, then the property will be sold, perhaps again, other siblings being able to buy at a discount.
- What form should ownership take? Families often use trusts to hold vacation homes, but there are other options. Siblings can simply own the property as co-owners with a family or operating agreement addressing the issues raised above. In some instances, it makes sense to use a limited liability partnership or corporation, usually when ownership interests are not equal. It can get complicated if the third generation gets into the mix with each owning a different share of the house, perhaps some owning a sixth, other's an eighth and finally some a one-twelfth interest.
As mentioned above, in my opinion, it is best that these questions be asked and answered while the parents are alive and healthy so that ultimately they set the ground rules with input from their children. Then the result needs to accepted. All of these questions can be asked later, once the next generation inherits the property, but then things can get difficult if they can't agree on the answer.