Louise Kramer
12/01/2005
For 50 summers, Ken Huggins had an idyllic retreat at his family’s oceanfront home on Nantucket Island off Cape Cod in Massachusetts. As a child, he particularly looked forward to fishing expeditions with his father, E.V. Huggins, a Wall Street tax lawyer turned Westinghouse executive. His own son, Jeff, caught his first fish, a scup, there at the age of 4, and Huggins has a vivid memory of the pride he felt watching Jeff—who is now 27—race home to show his catch to Grandpa. “I felt like a tradition had been passed from one generation to another,” he says.
Huggins, now 61, is an English professor at
Monroe Community College in Rochester, N.Y., and until a few years ago, he
assumed the end of every school year would mean it was time to pack up the
family and head for the beach house. When he was a youngster, he felt more
attached to the vacation home than to the family’s “real” house in northern New
Jersey, as did his brother and two sisters. “It didn’t have the magic of the
summer house.”When their mother died in 1997, 12 years after their father’s death, Huggins and his three siblings inherited the Nantucket property, which the family had expanded over the decades to two houses on seven acres. Even so, within the first few years, it became clear that there was not enough room for a bevy of heirs and their own families. Preteen squabbles resurfaced. One of the sisters, Judith Huggins Balfe, claimed that her other brother, Bob, got the best terms, just as he was treated the best when they were kids. Huggins was miffed because Judith had garden work done without consulting the others. There were spats over contributions for maintenance.
| TOP VIEW Happy summer memories faded when four grown siblings inherited their parents’ 10 beachfront acres on Nantucket Island, and internecine squabbling over its use and financing began to take its toll. Particularly in an environment that has seen property taxes triple and quadruple in luxury markets, watertight financial and estate plans are essential if you want a cherished vacation home to become a legacy that stays in your family. Beyond the finances, heirs also need a formal operating agreement to address everything that can tear a vacationing family apart, from philosophical disagreements to bickering over who owns the old outboard motorboat. |
Bob bought his siblings’ interest in the older house, as per the will’s terms, leaving them an endowment that was supposed to cover the operating costs for the second house. But property taxes escalated faster than the principal grew, and it became clear to the siblings that the endowment was not going to be enough to cover the annual operating costs. In 2003, they sold the house for $3 million. Shortly thereafter, Bob’s daughters sold his house. The family eventually reconciled, but Huggins believes that much of the acrimony could have been avoided.
Huggins now finds his fond memories clouded by the complexity and high emotion of managing and then selling the family home. When he and Judith, a sociologist who died in 2002, realized there were virtually no guides on inheriting and managing vacation properties, they wrote one themselves. The result is a 64-page book entitled How to Pass It On: The Ownership and Use of Summer Houses, available at www.Amazon.com.
A Business Retreat
Huggins is the first to point out that his family’s
plan failed to anticipate both the financial and the emotional concerns that go
into this kind of operation. “If I had the power to do things differently, I
would have involved all of us directly instead of working primarily through my
brother,” he says with the wisdom of hindsight.
Andrew Lee, a tax and estate
planning attorney at Howard & Howard in Bloomfield Hills, Mich., has seen
numerous estate plans that overlook the way posterity will run the vacation
home. Families imagine it will always be the place where worldly pressures end,
when in reality, when it passes to the next generation, it becomes a family
business. As with almost any business, it only develops more layers of
complexity as time passes and an increasing number of relatives become
stakeholders in the property—spouses, children and the children’s children, some
of whom may not know each other well. “You can have 30 people trying to chime in
about everything,” Lee says. “Management is the biggest issue.”
Lee
encourages his clients, as they are thinking about the terms of their estate
plans, to ask their children point-blank if they really want to own a share of
the vacation home. Everyone must be open-minded because this is an emotionally
fraught question; in many families the children are afraid their parents will be
crushed if they reject the scene of so many happy memories. It might turn out
that one child hates the five-hour drive. Another might prefer to build his own
dream retreat thousands of miles away. If only one child truly wants the
property, Lee suggests the parents apportion their other assets so that all
heirs feel they have received a fair share of the estate, assuming the parents
want to split their estate evenly.
If siblings are going to share the
property, however, trust and estate lawyers will almost always advise the
parents to create a legal entity to hold the property. In most cases a limited
liability company is the preferred structure for keeping all family members
invested in the project. Parents who are concerned that their children will not
be able to manage the property without an overseer can set up a vacation home
trust. As with all trusts, however, the terms will be difficult and expensive to
amend. Another drawback is that a trust expires when the last person named in it
dies, thus leaving later generations connected to the house—at which point, they
might be distant cousins—with no legal requirement to abide by the trust
agreement. Unless they are savvy enough to start over with their own business
strategy, chaos may blow the roof off, quite literally.
Within either
structure, parents can minimize the estate tax if they start transferring shares
of the property to the next generation early on. The government currently allows
individuals to make an annual exclusion gift valued at $11,000 per recipient.
Each parent can make this gift, and the gift can additionally be made to the
recipient’s spouse and children.
Operating Agreeably
Chris
Sega, a partner in Venable, a law firm in Washington, D.C., and a professor of
tax and estate law at Georgetown University Law Center, frequently helps
families create a formal operating agreement that will govern all procedures,
right down to the minutiae that can set siblings at war. (“You used my ski boat
without asking!”)
 |
Inevitably, one of the thorniest issues that an operating agreement should address is the actual schedule of who gets to use the house and when. The family should consider, and spell out, rules such as at what age a child becomes entitled to use the house alone, and whether there should be open weeks for the entire family to gather.
Then there are the rules about
comportment. If one sibling is a smoker, are the others willing to tolerate
lighting up indoors? Are cocktails appropriate when children or recovering
alcoholics are present? The family should also establish consequences for
breaking the rules, Sega says. He has clients who ban family members from visits
for repeated infractions.
Just like a post-college share in a beach house or
ski condo, family vacation homes should have one person in charge as calendar
keeper and another as manager and bill payer. There should also be a provision
to replace any manager who does not keep up with the work or cannot do it. Lee
suggests a new manager be elected annually and that the calendar keeper be
rotated so that no one feels overly burdened—or overly favored.
| Families imagine it will always be the place where worldly pressures end, when in reality, when it passes to the next generation, it becomes a family business. |
Financial basics Who pays the bills? Can the next generation afford maintenance costs? If additional funds are needed for capital improvements, who has to contribute and how much? Will there be a user fee to pay staff and caretakers? Does it make sense to rent out the property when the family is not using it? Will rental money be used to cover operating costs, or distributed among family members as income?
Whose house is it? Lee also recommends that families determine what constitutes an owner—a family unit or individual family member. As grandchildren become adults, they may want an equal voice in management; the operating agreement should address whether their view on an issue counts as a full or partial vote. There should also be rules about ownership claims from spouses if an heir gets divorced.
Meeting the overhead Sega suggests the manager create a budget at the beginning of every year to account for expected changes in expenses. Then, if appropriate, each owner should be assessed for that amount. Sega says that a vacation home typically costs about 5 percent of its value to operate. Thus a property worth $5 million would cost $250,000 a year to maintain. Sega recommends that parents seed the LLC or trust with cash or income-producing assets to maintain the property for at least a couple of years so that the heirs can have enough time to make sure their operating plan is in place and working.
How and when to sell The family should also decide in advance what circumstances would lead them to sell the property and how they would do it. These decisions will require a set of guidelines for family members buying each other out.
Unequal shares Sometimes co-owners will agree to allow a family member who rarely uses the house to make less of an annual contribution. If a co-owner wants to sell his share to the others, the family must have enough cash to purchase the share; for that reason, Lee recommends a limit on how many owners can sell at one time so as not to create too much of a financial burden on the other owners.
Family values The
owners should spell out in advance how they will value shares in the property
for sale to other members of the family, to avoid the horrors of internecine
litigation. Because these transactions do not take place on the open market, an
appraiser may value the share at 40 percent less than prevailing market rates,
Lee points out.
Illustration by Isabelle Arsenault/agoodson.com
Louise Kramer is a New York–based freelancer who writes frequently for the
New York Times.