Why would you put your vacation house in a Trust?

While it’s true that vacation homes can be held in a trust or even a corporation or several other entities, the limited liability company (LLC) form of ownership seems to be the most popular.

The LLC renders a blend of the flexibility of a partnership regarding tax planning and ownership, along with the liability protection of a corporation. When setting up an LLC for your vacation home, we can create a rulebook or operating agreement for the LLC and its owners. This document spells out the administrative authority, rights, and responsibilities of each LLC member concerning the property. This document can also be binding on heirs who are future owners of the home.

Unlike their corporation counterparts, LLCs are far easier to structure and require less maintenance and upkeep. The cost of setting up the LLC is by far outweighed by the benefits and potential cost savings enjoyed by its members. Setting up an LLC to hold all your second home or vacation property can be one of the best financial planning decisions you can make.

Five great reasons to hold your second home in an LLC:

Asset protection

An LLC can considerably limit the liability exposure at its owners (the LLC members). Take, for example, if a visitor of the vacation home has an unfortunate accident on the property, the family’s exposure in any settlement would be limited to the property itself.

Since this benefit is not found within trust ownership or joint individual ownership, LLCs allow family members’ assets, including primary residences, investment assets, and business interests, to be shielded from exposure.

Management of Property and Usage

A well-structured LLC operating agreement will set all terms of the agreement in writing, eliminating many disagreements and given family might have over their vacation home. The terms would include who is responsible for legal decisions, acquiring the proper insurance coverage, and the property’s upkeep. When and who can use the home (family members only versus non-family vacationers) will also be outlined, and the transition from parent to family members when the time comes.

Estate planning

Suppose the vacation home is not in the same state as your primary residence, and anyone’s interested as hell in individual names (not a Trust or LLC). In that case, the estate executor will have to open an ancillary probate which can be an expensive and quite lengthy probate proceeding.

Income tracking and expense dispersing

Since the LLC is its own legal entity, it will have a separate bank account with which the LLC members can operate the property. Any expenses, such as mortgage, repairs, or accounting services, or income made from renting the home, can be allocated among family members based on any predetermined criteria.

Buy-sell provisions

One significant advantage of putting a vacation home in an LLC is that it can happen to have “perpetual existence.” This will place transfer restrictions in the operating agreement, preventing family members or owners from selling their interests to anyone outside the family, or at a minimum, offering their interests to the family first. Additional clauses can be placed to stipulate who can become an owner, preventing ex-spouses from becoming owners, and requirements for appraisals, if helpful to determine fair buy-out prices and final sale price when placed on the market.

Caution: California property tax considerations

It’s important to note that while there are considerable benefits to holding additional properties in LLCs, you lose the 1 million parent-child exclusion from reassessment when the LLC, rather than a Trust owns the property.

Also, if more than 50% of the LLC interest is transferred, the change made to the membership of the LLC constitutes a change in ownership of the property, which triggers reassessment of their portion.

It’s essential for property owners and members of the LLC to work with an attorney who is up-to-date on Prop 58 and the change-of-ownership rules.