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Felhaber, Larson, Fenlon & Vogt
Felhaber, Larson, Fenlon & VogtFelhaber, Larson, Fenlon & Vogt

February 9, 2010

Articles

The Family Cabin
How to Keep it in the Family

If you, or a family member, own a cabin, chances are that you have thought about what can be done to keep it in your family. For many families, their favorite memories involve time spent together at the cabin. But when the original owner dies and the next generation has to decide how to divide the responsibilities, it is common for conflicts to arise. This can occur for several reasons. First, not all family members may be interested in continuing to own the cabin. They may be more interested in the accumulated value that the cabin represents. Second, not all family members have the financial resources to maintain the cabin. Third, if family members have never gotten along, it is unlikely that they are going to be able to work together to resolve the many issues involved with cabin ownership. Another factor is that if a cabin is left outright to the second generation, spouses of family members will also have an ownership share. A divorce or bankruptcy in one family affects all of the other owners.

If your goal is to maintain the cabin so that the next generation can continue to enjoy it, planning ahead is crucial. There are two different types of entities that you can create to solve many of the problems that result from common ownership. But, first you should understand why leaving the cabin to the children to own personally is fraught with difficulty. To illustrate this, consider a fairly typical family estate plan in which the parents leave their cabin in equal shares to their three children, Sally, Debbie and Mark.

During the probate process, Sally says that she has never wanted to own the cabin. She lives in a different state and has no children who can enjoy it. She is convinced that the cabin is worth $500,000 and wants Debbie and Mark to pay her what her fair share is worth. Debbie and Mark think that Sally’s valuation is way too high, but they aren’t able to convince her. Sally consults with an attorney and learns that as a co-owner of the property, she can force a sale. Angry with her siblings for failing to pay her what the cabin is worth, she starts a partition action against them. The cabin is sold and her attorneys’ fees are taken out of the proceeds of the sale. The siblings haven’t spoken since.

The legal right of any owner to force a sale of the property is a significant disadvantage, but there are others. Let’s say that Sally, Debbie and Mark are able to resolve all of the issues for the first three years after their parents’ death. However, in year four, Mark gets a divorce. As a result of the divorce proceedings, Mark’s wife is granted an interest in the cabin. She then remarries and her new husband likes the cabin. She now demands to use the cabin for two weeks of each summer. Sally, Debbie and Mark will need to work with her (and her new husband) to try and resolve the conflicts. If they can’t be resolved, each owner has the right to partition, as explained in the first scenario.

A similar problem occurs if one of the family members takes out a loan and uses the family cabin as collateral. The bank or mortgage company can end up with an interest in the cabin. If Sally, Debbie or Mark become strapped for cash, they can even sell their ownership interest to someone else. Needless to say, trying to work out the details of co-ownership with a third party is even more likely to result in conflict.

The potentially more serious issue of personal liability can also arise. For example, Debbie’s 17-year old son goes to the cabin for a weekend with his friends. They all drink too much, go out on the boat and get into an accident. One boy is seriously injured. The neighbor’s property is damaged. Lawsuits are brought by the neighbor and the injured boy’s parents against Sally, Debbie and Mark.

Hopefully, the above scenarios have convinced you that simply leaving the property outright to the children is not advisable. With careful planning, there are solutions to most of the problems that are caused by direct ownership.

Many cabin owners are choosing to form a separate entity which becomes the owner of the cabin. The two most common entities are a Limited Liability Company (LLC) or a Trust. An LLC is a company that is owned by its “members.” Following is a summary of the advantages of forming such an entity:

  1. The entity can establish an Operating Agreement which sets forth the basic rules of membership. The most important rule would restrict ownership in the LLC to family members. That way, outside third parties are not permitted to own an interest in the cabin. In addition, the Operating Agreement can provide direction on all of the significant ownership issues, such as how shares are transferred to children and what happens when a child wants to sell his or her share.

    Other issues typically covered in these Operating Agreements are how decisions are made about improvements and what happens when one member can’t afford to make contributions. Although inability to pay may eventually result in one family member having to sell his or her interest, the method of valuation and the buyout terms can be set in advance so that there is no conflict about this issue.
  2. A significant advantage of having an LLC is that a majority of members can decide how to resolve an issue. In contrast, as explained above, if family members own the cabin individually, they are not required to resolve the issues but can force a sale. While not everyone is always in agreement with the decisions that are made, most family members are willing to accept that in a democracy, the majority should decide the issue.
  3. An LLC offers limited liability. This means that if there is an accident which causes personal injury to a third party, none of the family members can be sued personally. This is an important consideration because of the higher risk for accidents at a cabin when there is swimming, boating and entertaining.
  4. Although the LLC is a separate entity, for tax purposes it is a “pass-through” entity which makes filing tax returns less complicated.
  5. An LLC can last forever. As family members change, only those who are interested in going to the cabin need to participate.

The disadvantages of forming an LLC have to do with the fact that the LLC is a formal legal entity. An attorney will need to draft and file articles with the Secretary of State. The family will need to spend time considering what the rules should be concerning the transfer of shares and even how to decide issues such as scheduling and maintenance. However, as explained above, if these rules are decided in advance, this greatly reduces the risk of family conflict down the road.

In addition to the extra work involved in setting up the LLC, family members must make annual filings with the Secretary of State’s office and have annual meetings. If these legal formalities are not followed, there will not be limited liability.

Another popular type of ownership for family cabins is a Trust. One advantage of this type of ownership is that many clients and estate planning attorneys are already familiar with this type of entity. A Cabin Trust can accomplish many of the same goals as an LLC. For example, the Trust can restrict beneficiaries to family members and can provide a procedure to follow if one family member wants to sell out. In addition, unlike the LLC, once the Trust is in place, there is no need for annual filings with the Secretary of State’s office or other legal formalities.

However, there are some significant disadvantages as well. An LLC is a “living” organization which is run democratically by the members. It can change over time as the wishes of the family members change. In contrast, a Trust cannot be changed. This means that a family might be able to create a Trust that includes all of the appropriate rules and guidelines at one point in time, but as the family members change, these rules become outdated. Although the Trustee can be given the authority to make changes, this is not as democratic as the LLC, which is run by a majority of the members.

Another significant disadvantage to a Trust is that the Trustee can be held personally liable if there is a lawsuit against the Trust. Many family members are reluctant to take on this responsibility when the cabin is a shared asset.

The most important thing that you can do if you are interested in preserving your cabin for your family members is to plan ahead. Ideally, there should be a family meeting to explore which family members are interested in owning the cabin. If some aren’t, they should be excluded (but perhaps provided with other assets to compensate for the cabin.)  For those members who are interested, you should discuss with them the various alternatives and that you will be working with an attorney to develop a plan to make it easier for them to resolve issues. You should stress with them that you are passing the cabin to them with the hope that they will be able to continue to enjoy it for generations to come.

Questions to Ask Yourself and Discuss with Your Family in Planning for the Future Ownership of Your Cabin

  1. Who currently owns the cabin? 
  2. Do you want the cabin to stay in the family if you are no longer able to use it and/or if you are no longer living?
  3. Are there certain members of the family that are more likely to use the cabin?
  4. Are there certain members of the family who definitely do not want to own the cabin?
  5. If you are no longer living or are no longer able to make decisions concerning the cabin, is there a family member you want to be in charge of making decisions concerning the cabin, or would you prefer to have all of your children involved in the decision-making process? 
  6. Is there anyone in the family who is currently doing a majority of the maintenance or using their own money to maintain or improve the property?
  7. If a child is not interested in owing the cabin with their siblings, should they be able to ask their siblings to buy out their share?  If so, should they receive full price for their share or a reduced amount in order to discourage them from asking to be bought out?
  8. Do your family members get along or is there likely to be immediate disagreement between them if they own a cabin together?
  9. If you are not living, do you want the cabin sold? Should any member of your family (or a person who is not a family member) have the first option to purchase the cabin? If yes, would this be at the fair market value at the time, or at a reduced price?
  10. Are you planning to sell the cabin during your lifetime?  Should any member of your family (or a person who is not a family member) have the first option to purchase the cabin? If yes, would this be at the fair market value at the time, or at a reduced price?
  11. Is there currently a mortgage or mortgages on the cabin property?
  12. Does the cabin property consist of one or more lots that could be separately owned by your family members?  If so, is this an option you are considering?
  13. How is time spent at the time cabin allocated?  For example, is time allocated based on a rotating basis among family members?  Is some other system used?
  14. If you are no longer living, would it be best that the cabin be owned by one or more but not all of the family members?  If so, will you make adjustments on how you pass on other property or assets of your estate to compensate the non-owning family members?
  15. If you are no longer living, how would your family members pay for the routine expenses of maintaining the cabin?  Would you consider leaving a sum of money in your Will for this purpose?

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