Summertime is a special time of year in Wisconsin. It brings many families to cabins where they create memories and traditions that will be cherished forever. However, many problems arise if families do not create a plan for the future ownership and management of the family cabin. The cabin may be subject to the claims of individual owners’ creditors, including spouses in the event of a divorce. Individual owners may freely transfer their interests in the cabin, and you could end up owning the cabin with non-family members. Individual owners may not pay their fair share of the property taxes and other costs associated with the cabin.
If individuals who jointly own the cabin disagree about an issue involving the cabin and the disagreement cannot be resolved, the legal remedy is to seek a partition action. In the absence of a settlement, the result of the partition action is a sale of the cabin at public auction to the highest bidder, which could be a non-family member. The net sale proceeds are divided among the individual owners. If there is significant acreage associated with the cabin property, a physical division of the property may be an alternative resolution.
The better course is to plan for the management and ownership of the cabin on a long-term, multi-generational basis. The key to a successful plan is an agreement among the individual owners, with input from current and future owners of the cabin.
The individual owners of the cabin must reach a foundational understanding regarding whether they will continue to own the cabin individually and enter into a written agreement, or create an entity through which they will own and manage the cabin. Some families think that managing an entity and the tax consequences of owning the cabin through an entity versus individually will be complex. However, the benefits of owning an entity that holds the cabin versus owning the cabin individually tend to outweigh any perceived negative consequences. Some of the advantages of an entity are the protection afforded to the cabin and the co-owners from claims of an individual owner’s creditors, the protection provided to an owner’s personal assets if a third party is injured on the property, and the ease and expense of transferring an interest in an entity versus transferring an interest in the cabin by deed.
Many families seek guidance regarding the type of entity they should use for their family cabin. One of the most frequently asked questions is whether to use a trust or a limited liability company (LLC). Here are the key features of each option:
- Trust – The individual owners transfer the cabin and sufficient funds to pay for the costs associated with the cabin into the trust. The trust beneficiaries are entitled to use the cabin, but generally there is no way for a beneficiary to convert his or her interest in the cabin into cash. The trustee of the trust will manage the cabin as long as there are sufficient funds to pay for costs, but the trust may eventually need to rent out the cabin to pay for expenses or the trust will need terminate. A trust is not a tax-friendly entity, which becomes an issue if the property is rented out. Trusts are taxed at the highest marginal income tax rate, beginning at a significantly lower amount of income, than individuals.
- LLC – The individual owners transfer the cabin to the LLC and, in return, they receive membership interests in the LLC. The LLC members sign a written operating agreement, which sets forth the rules for the ownership and management of the LLC, such as how the LLC is managed, how decisions are made, how and to whom members may transfer their membership interests, how expenses will be paid, and how the members will schedule use of the cabin, among other things. The members of the LLC have liability protection. An LLC is a tax-friendly entity, as all of the LLC’s income, losses, credits, deductions, and other tax items flow through to the individual members’ personal tax returns, with a few modifications.
Depending on the goals of a particular family, a trust may be the better selection, but most often LLCs are used for their flexibility, liability protection, tax consequences, and ease of use.
When families engage in a planning process that results in the creation of an LLC to hold their family cabin, they are prepared for success in the long-term ownership and management of the cabin. A well-reasoned plan, coupled with the participation of future generations of family members in the planning process, eliminates or minimizes the risks associated with the common ownership of the family cabin for many generations to come.