By Steve Thorpe
Legal News
When extended families try to sort out cottage ownership after a death or divorce it can create strains and divisions that can last for decades.
Dan A. Penning is the founder of The Penning Group with offices in the Detroit area, Grand Rapids and Traverse City and works primarily in succession planning for individuals, families and business owners. Penning is recognized as an expert in Cottage Law and helping families realize their goals of saving the family cottage.
He regularly prepares estate plans for clients to accomplish probate avoidance, estate and tax planning, and succession plans for businesses and cottages to preserve family assets for future generations.
Penning spoke recently with Steve Thorpe of the Legal News.
Thorpe: What would be a typical “horror story” in a cottage succession scenario?
Penning: The typical “horror story” is where parents leave a family cottage to multiple children as tenants in common (all own a fractional share of the entire cottage). The siblings/co-owners can’t get along to manage, pay expenses, schedule usage or deal with a co-owner(s) who wants to exit or sell his/her ownership interest. There is a complete breakdown of communication and cooperation which results in one or more owners suing the other and the only solution ultimately is the cottage is sold. The siblings/co-owners then lose the family cottage and often times lose each other resulting from the emotions and hurt feelings from the process. This happens regularly even in families where parents have told me “....oh, my children get along really well....”
Thorpe: What are some of the differences between traditional estate planning and cottage succession planning?
Penning: Traditional estate planning is usually not focused on the ongoing future management and use of assets such as the family cottage after title was distributed from a person’s trust or estate to the beneficiaries. The goal of traditional estate planning was usually to accomplish getting a particular asset to an intended beneficiary or beneficiaries and other times to minimize the value of assets for estate tax purposes. Cottage succession planning focuses directly on the setting up of a structure and system to facilitate the use, maintenance and future transfers of ownership among beneficiaries and even successor generations.
Thorpe: You’ve talked about how real estate law doesn’t usually take family cottages into account. Tell us about that.
Penning: Real estate law really only addresses forms of ownership and the resulting rights of ownership to individuals with respect to the real estate. Traditional real estate law really doesn’t address solving any issues or disputes between common owners of real estate with respect to use, maintenance or disposition of ownership. Essentially, real estate law applies rules to how real estate can be owned and what rights real estate owners have but does very little to address practical duties that individual co-owners have to each other.
Thorpe: Give us some of the potential tax implications of a cottage succession.
Penning: There is a new Michigan law that protects against property tax values uncapping based on certain transfers of ownership between family members. As a result, certain strategies need to be adopted to transfer ownership among family members first and then transfer common ownership to an entity like an LLC for succession planning purposes. Also, certain strategies can be implemented to protect the parents who may be residing in the family cottage and claiming it as their primary residence or a homestead exemption to be able to continue to claim the homestead exemption while still carrying out a cottage succession plan. Basically, several tax considerations regarding property taxes should be considered before transferring property by or among family members.
Thorpe: Tell us about the “right to partition” and how it affects cottage succession.
Penning: A “right to partition” is a legal statutory right in Michigan and most states whereby an individual owner can sue other owners to partition (split up or sell) commonly owned property. This impacts cottage succession planning really as an incentive to do planning which anticipates potential problems of common owners and provides rules to govern those situations so that co-owners have a viable alternative to solve their problems without having to sue each other for a partition. Most often, in partition actions, a family cottage is sold because there is not enough land to partition or split up the value of the land equally among its co-owners. As a result, instead of partition being the splitting up of land between the owners, it ultimately results in the sale of a cottage where the proceeds are then split up among the owners to compensate them for their ownership interest.
Thorpe: Tell us about entity laws and how you might use them to unsnarl the cottage knot.
Penning: My preference in cottage succession planning is to use limited liability companies as the entity of choice to accomplish planning objectives. LLCs provide extraordinary flexibility to establish management provisions among owners and are also pass through entities for income tax purposes. That being said, there are situations where more traditional planning strategies like a cottage trust can be an effective planning tool. The point is whatever the strategy, at least anticipating potential problems and having taken steps to solve them before they happen will go a long way toward keeping the family cottage in the family.
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