Vogel Law Firm, Ltd.: estate planning law firm serving families throughout the State of Wisconsin

Thursday, August 31, 2017

Cabin Trusts and Liability Issues

Many clients have contacted me regarding the establishment of a trust to hold a family-owned lake home, hunting land, or other piece of treasured real property tied to the family. A question that often comes up in my initial discussions with clients is whether a trust or limited liability company (LLC) should be used as the vehicle for this purpose. Clients know that simply deeding the cabin to their children is not always a viable option. The clients need to create structure and procedure for the management of the property.

There are many articles written on websites related to the advantages and disadvantages and comparisons between using a trust or LLC to hold and manage family property on a long-term basis. When a trust is used, the family members, who are in line to inherit the cabin, are long-term beneficiaries of the trust. If drafted properly, the generations beneath the initial beneficiaries are future beneficiaries of the trust. The beneficiaries of the trust do not own the cabin. A trust is a unique legal relationship between the trustee and the beneficiaries. Typically, one or more children are selected to serve as trustees of the cabin trust.  A trustee is also not the precise legal owner of the cabin.  Moreover, the beneficiaries do not have an ownership interest in the trust. They have a beneficial interest. With an appropriate spendthrift clause in a trust, the assets held by the trustees are protected from the creditors of the beneficiaries. For example, if a beneficiary is sued in the future or must file personal bankruptcy, the beneficial interest in the trust is protected from the creditors of the beneficiary. Further, if a beneficiary divorces, the beneficiary's beneficial interest in the trust is not an asset that is divisible in a divorce proceeding.

The management and usage of the cabin is controlled by language in the trust.  This language may be amended in the future to accommodate for unforeseen contingencies that may come up years or decades after the original owner or owners of the cabin have died.

A cabin trust is typically irrevocable upon being funded with the cabin (i.e., the cabin is deeded to the trust). Funding usually occurs upon the death of the parent, but could occur earlier depending upon the circumstances. Many confuse the ability to revoke a trust with the ability to amend a trust. If appropriate language is used in a trust document, an irrevocable trust may be amended, but the trustees and beneficiaries may not revoke or terminate the trust other than pursuant to the terms of the trust or applicable state law.  However, depending upon how the irrevocable trust is written, the trustees and/or beneficiaries may amend the trust.  For example, the trust may provide that a majority or super majority of beneficiaries have the right to amend the trust. I have read many other articles related to LLC or trust usage for cabins, and the writers often speak of irrevocability in the context of amendability. These legal concepts are not the same. Irrevocable trusts often may be amended. In addition, Wisconsin trust law permits trustees and beneficiaries to modify trusts in many circumstances without court involvement (e.g., Nonjudicial Settlement Agreements). The assets of a trust may also be decanted into a completely new trust instrument with brand new language.

When an LLC is used to own the cabin, the LLC owns the cabin.  In addition, the family members, who are in line to inherit the cabin, are members of the LLC.  An LLC has members, which is a concept similar to shareholders of a corporation.  If the LLC structure is used to own the cabin, then each member (e.g.. typically a child of the prior cabin owner), owns a percentage interest in the LLC. The membership interest is the child's asset. The worst possible situation in the LLC context is an aggressive creditor coming after a member of the LLC and obtaining an assignee's interest in the LLC. This essentially means that the creditor becomes an owner of the beneficiary's membership interest. If I am this persons brother, I do not want to have a creditor involved with the family cabin. This could happen in a lawsuit or bankruptcy proceeding. In a perfect world with children or grandchildren, who never have creditor issues, the LLC form would be very useful; but the creditor risk should cause a client to ponder the negative aspects of this situation. Also, if a member divorces, the member's ownership interest in the LLC is an asset of the marital couple. While the law generally provides that inherited property is not subject to a divorce division, the membership interest still must be disclosed on financial disclosures and statements used in divorce proceedings. This is much different than holding a beneficial interest in an irrevocable trust.

The management and usage of the cabin is governed by an operating agreement for the LLC. The operating agreement is basically a partnership agreement between all persons owning an interest in the LLC. This operating agreement is flexible, but as time continues and the ownership interest of one member transfers to the member's children due to death, the ability to obtain the percentage of ownership interest required to amend the operating agreement may prove difficult.  This is different from a trust. A trust can includes two means of amendment.  The trust may be amended by the trustees and also amended by the beneficiaries.  If a trust has three trustees and 20 beneficiaries, the trustees do not always need to obtain the written consent from a majority of beneficiaries to amend the trust to address a needed change, a majority of trustees could make the necessary amendment. This provides an additional functionality for the trust compared to the LLC.

Whether a trust or LLC is used, it is best to also fund the trust or LLC with sufficient cash to maintain the cabin for many years to come, which would include money for property taxes, insurance, and repairs. If the LLC or trust is not funded with ample cash, there will be immediate conflict about who is responsible for paying these expenses. While the trust and operating agreement can both address payment of expenses, the ease of available cash is far superior tool.

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