You dream of a cottage by the sea. Or, maybe it’s a ski chalet or a lodge in the woods.
No matter where your vacation home dreams take you, second homes are expensive. Most of us don’t have the time to care for our primary home and a second residence. What about splitting the obligations of a vacation home with a family member or friend?
Sharing the load sounds great on paper, and you may already be sharing a vacation rental with friends or family. But purchasing a second home with a relative or friend can be risky. If things don’t go well, you risk damage to your friendship and a possible legal battle over the property.
Don’t panic! Before you sign on the dotted line, ask yourself these important questions to protect your finances and leave your family ties and friendships intact.
TIC or LLC?
Ownership of property by two or more parties who are not married can be setup as a limited liability corporation (LLC) or a tenancy in common (TIC). Setting up an LLC will mean hundreds of dollars in additional fees and more paperwork, but it can make it easier to give away or sell an interest in a vacation home. You are treated like an individual for tax purposes but you have the extra protection of a corporate liability shield. You’ll need to draft an operating agreement to establish the obligations and rights of the members in the LLC.
Here’s why this matters: Under a TIC, someone who is injured while in your shared vacation home can sue you and the other co-owners for all you are worth. And, because you own the home with someone else, you have less control over who can be allowed into the house. If your nephew wants to celebrate his high school graduation with a blowout party on your vacation home, and somebody steps on a broken glass, it can come back to bite you. This is much less of a risk if you choose an LLC.
Who is responsible for what?
Another reason to set up an LLC rather than TIC is that LLCs are normally required by law to have an operating agreement. This agreement, which should be drafted by an attorney, clearly explains everybody’s ownership interest.
That ratio – whether it’s 80:20 or 50:50 – determines how costs like real estate taxes and insurance are divided. The agreement should also clearly explain who the manager of the vacation home is and how capital improvements and maintenance will be performed and paid for. This agreement gives the owners a guideline so that everyone knows what the parameters are before you even buy the place.
Think of it as a real estate pre-nup. It’s there to ensure that things run smoothly and head off resentment at the pass. Otherwise, any issues you haven’t discussed – like who is supposed to close up for the season – can quickly and easily become emotional.
Who gets which holidays and weekends?
Will you all be at the house at the same time or alternate using it? Most vacation homes normally have a prime period of just a few months.
Normally, everyone wants to be at the house at the same time of the year – like school vacations or holidays. If you and the other owners don’t talk about this in advance, it can lead to everyone showing up on the same day. Not exactly a relaxing way to start your vacation.
If you decide to split the time, work out an annual schedule in advance. Consider rotating who gets major holiday weekends, and you should agree that swaps and changes can be made but only with the permission of all the parties involved.
To rent or not to rent?
No matter how many co-owners you have, there are times when your vacation home is going to be empty. If you’re picky about neatness or don’t like the idea of strangers sleeping in your bed, you probably don’t want to rent out the home.
But what if another co-owner wants to make some cash by renting the place out?
Before you buy, decide together whether you are going to rent out the vacation home. If everyone agrees to rent it out, ensure that where you are purchasing will allow you to do so. Some communities do not allow short-term rentals.
What happens if somebody wants out?
Have at least one conversation about how long everyone wants to be involved and what will happen if someone wants to sell. One way to reduce conflict is to give the other owners right of first refusal if you want to sell your share. Think about whether you’d be able to buy out a co-owner or if you can cover the extra maintenance and mortgage costs if someone wants out.
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