Passing the Cabin on to Family

lakecabinThe Lake is truly a magical place. For years or perhaps decades, family, friends and loved ones have gathered at the family cabin to build and share memories that span generations. The fun-filled campfire conversations are priceless. Of equal importance, are the conversations spent discussing the future of the family cabin.

If your goal is to pass on the family cabin to the next generation, planning ahead is crucial.  Together you can determine how the cabin will best fit into the family’s future. For example, perhaps not all family members are interested in continuing to own the cabin or perhaps not all family members have the financial resources to maintain the cabin. Inevitably, part of the communication process involves the preparation of an estate plan. The plan must be tailored to fit your family’s needs. A cabin trust just one estate planning tool that can be utilized to help maintain and pass on the family hideaway. For example, specific trust provisions could provide future instruction to your family on important issues such as taxes, maintenance, insurance, ownership and a potential sale.

Through open, honest communication and with the right planning, you and your family can ensure the family cabin remains a source of joy and respite for your family. The preparation of an estate plan should be thought of as a priceless preventative tool. Talk with your family today and take that next step of developing an estate plan that protects both your family and your private hideaway.

Setting the Stage for Future Generations to Keep the Cabin

Problems frequently arise when the “do nothing” plan results in equal undivided interests in the adult children as tenants in common, whether they acquired title in that fashion as a result of lifetime gift, or inheritance by Will, Trust, or intestate succession.  The Attorneys at Klun Law Firm will help you navigate the estate planning waters.  For over 30 years, we help helped thousand of families pass on the family cabin.

The Usual Problem: Unequal Use, Maintenance, and Payment of Costs

The common situation is where three adult children, for example, inherit the cabin. One pays the majority of the costs, and the other two will justify that to themselves and to each other by referring to the fact that this adult child has the best ability to pay. A second adult child is a handyman, and is constantly at the lake fixing things and keeping the place maintained. The other two children may justify that by stating that this adult child is the best at doing this.  A third adult child is an avid fisherman, and doesn’t chip in much at paying the expenses (he’s put too much money into his expensive boat) or helping out with maintenance (it takes time away from being out on the water, and that’s what it’s all about, anyway). Layered on top of this is that the cabin can’t accommodate all three of them with their families at once. They need some sort of lottery system to address the use. Add to the facts that child one lives out of state, loves the place dearly, and really wants exclusive use of it during July 4th week, and we have the formula for disaster. Unfortunately, cabins have been sold in many of these situations.

Other Concerns

There are a number of other issues that also arise if this is considered in a long-term perspective:

  • What if one of the adult children dies?
  • Is the one-third interest an available asset if one child goes to a nursing home?
  • What if one of the one of the adult children has a financial problem: bankruptcy, judgment, tax lien, or child support arrearage?
  • How to handle major repairs or improvements to the property?

Cabin Trusts

One answer to the problem, probably from an estate planning attorney, is to use a trust agreement. They may include a life estate to an aging parent or parents, and leave ownership in the trust itself until the last of the adult children dies. At that point, the trust can distribute to the grandchildren of the settlor. To avoid a violation of the rule against perpetuities, the trust probably shouldn’t continue beyond the generation of the adult children.

Advantages of Cabin Trusts

  • Familiarity. Trusts are entities that estate planners use all the time. Existing trust forms can be modified to work.
  • Superior device for distribution. Trusts are true estate planning entities, and probably work best at the distribution to the right people whenever they terminate.

Drawbacks of Cabin Trusts

  • No perpetual existence. They don’t have perpetual existence, because the rule against perpetuities applies.
  • They aren’t easy to amend. They are either irrevocable in the first place if they are intended to shelter from nursing home costs, or else they become irrevocable once the aging parent/settlor dies.
  • Shares can’t be changed. The shares can’t be changed over time to reflect the unequal contribution of labor or money or the unequal use of the property.
  • Distribution can’t be changed. The ultimate payout provisions are probably cast in stone. About the only flexibility that can be easily built in is a general or special power of appointment.
  • Who is the trustee? This can be a true dilemma. Are all three adult children named as co-trustees, and a majority vote sufficient to bind the trust? Is one child chosen? Is there any power of removal?
  • Difficulty in fulfilling fiduciary duties owed to remainder beneficiaries. The adult children are essentially lifetime beneficiaries of the trust. If they also serve as trustee(s) and make certain decisions benefitting them individually and negatively affecting the remainder beneficiaries, their fiduciary duty may have been breached.

Using a Business Entity

Using a business entity seems to make some sense to eliminate some of the above problems.

Advantages of Using a Business Entity

  • Perpetual existence. An entity with perpetual existence solves a number of the problems.
  • Ability to amend controlling documents. The ability to amend the controlling documents over time is very appealing.
  • Ability to alter the shareholders and number of shares. The ability to alter the number of shares is probably something that the family will want or need as time goes by.
  • Transfer restrictions. Just as any other small business entity, one established for ownership of the cabin can contain transfer restrictions intended to accomplish several goals: preventing sale to an outside party without agreement; valuation and payment provisions in case of a bona fide sale; and valuation at lowest justifiable level and payout provisions at the slowest possible rate in case of divorce, bankruptcy, or other involuntary transfer.

Disadvantages of Using a Business Entity

  • Legal and Accounting Fees. The costs of establishing the entity and maintaining it are new expenses the family hasn’t had in the past.
    • A corporation or LLC will need corporate minutes and will need to generally comply with the formalities of any small incorporated business to maintain its integrity as a separate legal entity. If a business entity is used to make the cabin an unavailable asset for Medical Assistance purposes, this should be taken seriously by both the attorney and the family.
    • If any income is recognized, there will be additional tax returns. The entity will need an employer’s identification number from the IRS. From a tax perspective, it is probably cleanest to recommend an entity that is a pass through entity, reporting its income, deductions, and credits to the shareholders on K-1 schedules without any change in character.
  • Need for a “Business Purpose.” Minnesota’s business entity statutes require a business purpose. If an entity is scrutinized by the IRS in a tax audit, it will need a business purpose. Query whether this is met by owning real estate for future appreciation in value. Payment of rent by family members should fulfill the requirement.
  • Loss of Potential to Exclude Capital Gains on Sale. Had the cabin been kept in mom and dad’s names individually, they could have potentially made it their principal residence within the tax code definition to exclude gain on sale. The 1997 amendment to the tax code permits exclusion of up to $250,000 of gain by an individual or $500,000 by a married couple on the sale of their principal residence. The property must have been their principal residence for two out of the last five years. IRC §121.
    • Many Minnesota snowbirds have sold their lifelong family home (excluding the gain on the sale under §121) and used the proceeds for “fixing up” the cabin and purchasing or renting a place in the sunbelt for the winter months. If the cabin is later sold, the gains on its sale can also be excluded under §121 if the “two of the last five years” test is met. The exclusion is available to the taxpayer as often as every two years §121(b)(3). Short absences, such as two-month vacations, don’t interrupt the period of use, even if the property is rented out during those times. Reg. 1.121-1(d). Considering that most cabins have considerable gains against them, this can be the loss of a significant tax advantage.
  • Loss of Potential to Receive Minnesota Homestead Real Estate Tax Exemption. If mom and dad sell their house, move to the cabin as their primary residence, and hold title individually, the cabin should qualify for the Minnesota homestead real estate tax exemption. Minn. Stat. §273.13, Subd. 22. Changing ownership to a business entity will result in loss of the exemption because businesses don’t qualify. Given the difference in rates, this can be a big drawback that should be discussed with clients and memorialized in a letter to avoid finger pointing later.