Few, if any, people (outside of lawyers) view this family haven as a risk of future discord and, possibly, litigation, but cottages, under typical ownership arrangements, present real legal and practical issues that tend to compound with each successive generation, as the number of owners increases (the more owners, the more opportunities for conflict). By typical ownership arrangements, I mean direct ownership, namely the ways in which most people are accustomed to owning and managing inherited real property: as tenants in common, and as joint tenants, which are similar, but not the same.
Our purpose here is not to provide detail on the largely archaic law of real property in the United States. Rather, our goal is to identify issues and encourage cottage owners to evaluate their own cottage succession plan. In the absence of a comprehensive cottage plan, most owners leave their property to their children, or other heirs, as tenants in common or in a form of joint tenancy. In Michigan, joint tenancy raises two very significant additional issues, both of which warrant and would require their own article: Michigan’s property tax uncapping law, and the fact that Michigan law recognizes two distinct types of joint tenancy, which can create dramatically different outcomes.
For purposes of cottage planning, tenants in common and joint tenancy share most of the same traits. The main difference, in simple terms, is that a typical joint tenancy with rights of survivorship is essentially a contest to see which joint tenant lives longest; the last survivor gets the whole pie. A typical joint tenancy can be severed into a tenant in common arrangement. Tenants in common, the default arrangement, means that each owner has equal rights to the use of the property, regardless of their ownership interest. There are a whole host of other reasons why it is not a desirable arrangement, but listing those reasons is outside the scope of this article.
What is important to understand about tenants in common (and one type of joint tenancy) is that each owner has the right to partition the property. With respect to a family cottage, this is truly the outcome we are seeking to avoid. An owner’s right to partition means they can demand that the court either physically divide the property, and failing that, order its sale, with the distribution of proceeds prorated among the owners.
In addition to preventing the very unpleasant reality of partition (which often permanently damages, if not outright destroys, family relationships), a properly assembled cottage plan can address or avoid the following issues, among others: family disagreement on matters relating to the cottage (including operation, maintenance, improvements, rental, usage, cost sharing, etc.); transfer of ownership to a spouse, through divorce or death; attachment of ownership interest by creditors, and the ability of owners to mortgage or sell their interest; inability or unwillingness of an owner to meet financial obligations of ownership; and, an owner who wants to cash out their interest.
A properly prepared cottage succession plan will be generally be designed to achieve these core goals: keep ownership in the line of descent; allocate ownership and control/decision-making authority; balance richer owners and poorer owners; create a structure and system for scheduling use; define how to handle holdout or free-rider owners; and, how to handle, or whether to allow, renting of the cottage.
I believe that the best way to achieve these goals is through indirect ownership, and especially through the use of a limited liability company (LLC) set up expressly for this purpose. One of the key benefits of indirect ownership is that it limits owners’ personal liability for accidents that may happen at the cottage. It is not hard to imagine situations where this would be important, so I will spare you any unpleasant examples. LLCs, in particular, offer numerous additional benefits, while providing more flexibility, tax benefits, longevity, and ease of use than other indirect ownership methods like trusts or corporations.
An LLC is a business entity whose operations can be defined and controlled, with great flexibility, in an Operating Agreement. This document can define ownership and place restrictions on who can be a member and how ownership interests can and cannot be transferred. As a sample, it can also prevent partition, provide mechanisms for collecting assessments and imposing sanctions on free-riders, allow for various voting and control schemes, allow for pass-through income and losses, hold an endowment (for instance, funds from a life insurance policy, to pay taxes and upkeep), provide a system for scheduling/allocating use and/or rental, and allow for amendment of its own terms. LLCs are typically less expensive and less formal than a corporation and are generally simpler to organize and maintain, as well.
Hopefully, this quick survey of cottage planning issues is useful for identifying areas in which your, or your family’s, plans could use additional attention. The overarching goal is to preserve the family cottage, within the family, while mitigating the risks of liability, future family disagreement, creditor issues, and so forth. A proper cottage succession plan will give your family its best chance at passing the cottage down to several more successive generations, where memories can continue to be made with minimal risk of unpleasantness or discord.
One very important cautionary note to conclude: as I mentioned, Michigan has a property tax uncapping law, which can be particularly troublesome for cottage owners. Transferring your cottage, into an LLC or to any other person or entity, may have significant property tax consequences, and I recommend you consult with an attorney before making any such transfers. Further discussion of this thorny issue will have to wait for a future issue.
Author: Adam S. Russell is an estate planning attorney at Tuesley Hall Konopa, LLP. Practice areas include trust and estate planning, estate administration, tax planning, charitable planning, and charitable trusts, trust funding, special needs trusts and supplemental needs trusts, prenuptial agreements, and probate. Additionally, Adam is licensed to practice in both Indiana and Michigan and regularly meets with clients in our South Bend, Elkhart and Cassopolis offices.
You can contact Adam by calling 574.232.3538 or by email firstname.lastname@example.org.