Family Cabins in LLCs

Some families have a cabin, condominium or second home they use as a place to get away and enjoy some relaxation.  Usually, the parents own that cabin and pay all of the costs of keeping and using it, yet all family members use the cabin.  What will happen to the cabin when the parents die or get too old to manage it?

To keep ownership of the cabin in the family, some families have transferred the cabin to a corporation with each family member owning shares in the corporation.  But what will happen when the day comes that the cabin must be sold?  If it is owned by a corporation, there could be income tax to be paid by the corporation and again by the shareholders when the sales proceeds are distributed. That is distasteful. There is a bigger problem looming.

How will money be raised each year to keep up the cabin–to pay the utilities, property taxes, fire insurance, repairs and maintenance, association dues, permit fees, etc.?  Shares of most corporations are not assessable.  Thus, a shareholder cannot be forced to pay money into the “pot” for his or her share of such costs.  Also, use of the cabin will not be equal within the family–some family members will use it more than others.  How to account, and pay, for that difference in use?

Here is where an LLC may be helpful.

A limited liability company (LLC) is a type of business entity that is a cross between a partnership and a corporation, with characteristics of each.  LLCs have the flexibility of partnerships with the shield of limited liability like corporations.

An LLC is an entity separate from its members.  Being a separate entity, an LLC has its own powers, rights and limitations; it can own property and bank accounts, sue and be sued, buy and sell assets, and do everything that any other entity can do.  Yet it does not pay income taxes since all items of income, gains and deductions “pass through” to the LLC members based on percentage ownership.  And an LLC is flexible. Its governing documents can be prepared to say whatever the family wants them to say.

So the parents could set up an LLC to own the family cabin.  Initially, they make themselves the only members (owners) of the LLC and make themselves the initial LLC managers.  They convey the cabin to the LLC.  Then, with proper advice, they make gifts of part of their ownership to each of their children, thereby making the children members (owners) of the LLC along with the parents.  The parents open up a bank account for the LLC.

The parents have utilized a “manager-managed” LLC to own the cabin. This gives the parents the power to run the LLC and the cabin so long as they are the managers.  The children, as members, do not have the power to bind the LLC since they are not the managers.  So far so good.

The LLC documents include provisions to require the following:

  • rules for scheduling, using, cleaning, securing and winterizing the cabin and outside area
  • a guest log book to be signed by all users
  • payment of “use fees” by those who use the cabin, based on days and extent of use
  • annual assessment of members, based on percentages, for the capital costs of owning and maintaining the cabin
  • procedures for selling an LLC interest of a family member who does not pay his or her share of assessments
  • rules for transfers of LLC interests within the family
  • protocol for maintaining communications in the family regarding the cabin
  • protocol for changing managers of the LLC
  • guidelines for member voting to approve any sale or remodeling of the cabin

If the family members are willing to pay to use the cabin, usually at bare-bones cost, then things will go along smoothly so long as all members pay what they should and they pay on time.  But what if they don’t?  There are choices here: either there is an enforcement mechanism to collect fees and assessments with possible sale of a member’s LLC interest as the last resort, or the parents (usually) could put a sum of cash into the LLC in amount sufficient to generate interest to carry the annual costs of owning the cabin.  That could require a significant sum.  But that shows the whole family the true cost of owning and enjoying the cabin.

What about taxes? The LLC is a pass-through entity, meaning that it does not pay income taxes.  Of course, until the cabin is sold, there will not be significant income, only expenses along with assessments and use fees to pay those expenses.  Who gets to deduct those expenses? Most of those expenses will not be deductible by anyone since they are personal expenses, similar to the expenses of running a primary residence.  Yet, property taxes should still be deductible by the owner of the property–the LLC and through it, the LLC members.

To take full advantage of the LLC form, advice and assistance from a competent lawyer are needed.