May 10, 2022—Many parents want to keep their cherished vacation home in the family for future generations but are not sure of the most appropriate method for transferring the property. In this podcast, Director of Wealth Strategies Matthew Lee of Wilmington Trust’s Emerald Family Office & Advisory discusses how holding property in a limited liability company (LLC) may accomplish several goals at once. This particular estate planning method may facilitate the transfer of the home from one generation to the next in a tax-efficient manner, simplify estate administration, and put a governance structure in place for a treasured family asset.
Planning for the Family Vacation Home
Hi, thank you for tuning into today’s Emerald GEM, which stands for Get Educated in Minutes. I’m Matthew Lee, director of Wealth Strategies for Wilmington Trust’s Emerald Family Office & Advisory and your host for today’s podcast. In today’s GEM, I’m going to answer the question: How can holding a vacation home in a limited liability company enhance an overall estate plan?
Here at Wilmington Trust, we often work with clients who own vacation homes in addition to their primary residences. Frequently, these properties have significant economic value, sometimes comprising a sizable portion of a client’s overall net worth, but also hold sentimental value as the location of cherished family memories, holidays, and other milestone events. Because these properties can have such great value, both monetary and emotional, it’s critical that they be specifically incorporated into an overall wealth and estate plan.
When it comes to planning for a vacation home, no one plan is going to be right for every family or every type of property. Like the families and homes themselves, each plan needs to be unique and customized to meet the specific goals of the family and to address the particulars of the real estate. The right plan could include holding property in individual or joint name, in the name of a trust, whether revocable or irrevocable, or in the name of an entity, like a limited liability company or partnership. Sometimes it includes a combination of these, for example, holding property in an entity that’s owned by a trust.
Each of these options should be considered when incorporating a vacation home into an estate plan before deciding on the best course of action. On today’s podcast, we’ll focus on one particular strategy—holding property in a limited liability company, or LLC, and discuss how that could accomplish a number of common planning goals, including facilitating wealth transfer, simplifying estate administration, and implementing a governance structure. And with that, let’s get to it.
One of the most common estate planning goals is to facilitate the transfer of wealth from one generation to the next in a tax-efficient manner. Placing a vacation home in an LLC could accomplish this objective in several ways. When a property is transferred to an LLC, that LLC could be owned by one individual, known as a single member LLC, or multiple individuals, known as a multimember LLC. In the family context, this means that a parent or grandparent could be the initial owner, or member, but over time they could elect to gift some or all of their ownership to junior generations, such as children or grandchildren. While transferring equity ownership of the LLC, the senior family member could also choose to retain certain managerial powers, allowing him or her to effectively operate and maintain the vacation home while still transferring partial ownership to the next generation.
“Fractionalizing” ownership and responsibilities this way facilitates an orderly transfer of an important family asset and does so in a tax-efficient manner. By gifting fractional interest in the LLC, and thus the underlying real estate, a senior member of the family is able to take advantage of the historically high lifetime exemption from federal gift and estate tax—roughly $12 million per person at the time of this recording. Moreover, because the junior family member is only receiving partial interests in the LLC, which may or may not have limited rights associated with them, certain discounts may be applied to the value of the gifted interests, potentially reducing the amount of exemption used on that transfer. These discounts, which could be for lack of control or marketability, could be as much as 30 percent or more, depending on the particular facts and circumstances, allowing the senior member to substantially leverage their lifetime exemption.
Likewise, when a senior member passes away, discounts also may be applied to the value of their retained interest in the LLC when determining their estate tax liability. This could mitigate their estate tax exposure at death, and thus potentially reduce estate taxes paid. Therefore, by holding the real estate in the LLC, the senior family member could transfer the property to their family members, either during lifetime or at death, tax efficiently.
Another common goal in estate planning is to streamline estate administration, which can be costly and time-consuming for a family. Clients are often looking for ways to simplify matters and holding a vacation home in an LLC could accomplish that objective. If the proper provisions are included, an LLC’s governing document, known as an operating agreement, could spell out how an ownership, or membership, interest is transferred at death.
For example, the operating agreement could provide that, at death, a deceased member’s interest passes to other surviving family members. In this regard, the agreement acts as a will substitute, allowing an interest in the LLC to pass outside of a deceased member’s will, thereby avoiding probate. When a vacation home is in a state other than the owner’s primary state of residence, this would be especially important. If that were the case, a second probate would be required in the state where the property is located, compounding the cost and time associated with the administration of the estate. Transferring property to an LLC would avoid that result. Instead, the membership would pass according to the terms of the underlying operating agreement, greatly simplifying matters and accomplishing that common estate planning goal.
Although vacation homes can be a source of great joy, unfortunately they can also become a source of family tension, especially after the passing of a senior family member who previously owned, maintained, or paid for the property. Holding the home in an LLC could help to mitigate that risk. In addition to facilitating wealth transfer and simplifying estate administration, an LLC can also be beneficial in creating a sustainable governance structure for a treasured family asset. As I noted earlier, an LLC would be governed by the terms of its operating agreement. Among other things, the agreement could include provisions around how the vacation home is to be used, maintained, and paid for, all of which, if unaddressed, could become sources of tension in the family.
For example, the agreement could spell out when or how often different branches of the family could use the property, and what their responsibilities are for maintaining it, both in terms of financial commitment and sweat equity. The agreement could also specify how and under what terms a family member could exit from their ownership of the LLC or new members could be added. This could be beneficial to avoid the undesired family strife that can occur if a family member no longer wishes to use the vacation home or upon the unanticipated death or divorce of a family member. As a family changes over time, it’s critical that the governance structure that owns their prized vacation home be able to evolve along with them. Since the operating agreement can be amended as needed, the LLC provides the flexibility that many families need, hopefully reducing the risk of family discord that could arise in these circumstances.
On today’s podcast, I’ve touched on some common estate planning goals that could be achieved by holding a vacation home in an LLC, but there are other benefits as well. To name a few, holding a property in an LLC could also add a layer of privacy where a family wishes to own property discreetly. It could also provide additional creditor protection for the family and the property, which could be especially important if the home were ever to be rented. As I noted earlier, these potential benefits and other relevant considerations should be carefully reviewed by you and your legal and tax advisors before finalizing any plan for your cherished vacation home.
Thanks again for joining us today. I hope you found our GEM to be helpful. Please contact your Wilmington Trust advisor if you have any questions about your family’s vacation home and how holding it in an LLC can enhance your estate plan. We would be glad to help you. If you have a topic that you would like us to discuss on a future GEM, please let us know. Send an email to Emerald@wilmingtontrust.com. See you next time!
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The information provided herein is for informational purposes only and is not intended as a recommendation or determination that any tax, estate planning, or investment strategy is suitable for a specific investor. Note that tax, estate planning, investing, and financial strategies require consideration for suitability of the individual, business, or investor, and there is no assurance that any strategy will be successful.
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