Financial lessons learned from family cottage owners

Share

Last week I wrote about family cottages, which sparked a flurry of e-mails and a couple of conversations with readers who had their own experiences to share. One woman insisted that bad luck follows her everywhere. "Tim, if I sold a pair of pants to a thrift shop for a dollar, I'd probably forget about the twenty-dollar bill in the pocket" she said. A few of these folks felt that others could learn from their cottage challenges. So, here are three real stories that we can learn from. Their names have been changed.

Beware of joint ownership

In this story, Ruth owned the family cottage with her two sisters. They inherited the property from their parents and the cottage was owned jointly with right of survivorship (JWROS). JWROS means that two or more people each own an undivided interest in the whole property. That is, all three sisters in this case were considered to each own the whole property. When one passes away, the surviving joint owners then inherit the property. In the end, it's the last surviving owner that will inherit the property alone.

Ruth passed away and her two surviving sisters now own the cottage. The problem? Ruth's kids, who use and love the cottage very much, will never inherit an interest in the property. Who knows, they may not be invited to continue using the cottage. This wasn't the intention of Ruth's parents when they left the place to the three daughters jointly.

If you're leaving the cottage to the kids equally, consider placing the property in their names as "tenants in common" instead of JWROS. This way, each owner will have a divided interest in the cottage and can transfer their share to whomever they want, during their lifetime or upon death in their will. Ruth could have left her share of the property to her kids if it had been owned as tenants in common.

Avoid bare trusts

Then, there's the story of Jack, and his brothers Ken and Richard. A few years ago, their father transferred the family cottage into Ken's name alone, with the understanding that Ken would hold the cottage for the benefit of all three sons.

This is really a trust arrangement. It's known as a "bare trust" because there is no trust agreement to spell out how the property should be managed. The sole duty of a bare trustee is to deal with the trust property upon the direction of the beneficial owners (all three brothers in this case).

The problem? The brothers can't agree on much to do with the cottage – from whether to do renovations, to how they should share costs. So, Jack is not a happy camper – or cottager. Jack's father would have been wise to create a formal trust, rather than a bare trust, with written terms to guide decisions around the use, maintenance, and costs of the cottage. Alternately, he could have initiated the creation of a "Cottage Agreement" (or "Beneficial Owner's Agreement") to which each son would be a party.

Create an endowment

When Janice's mother died, she left the family cottage to Janice and her brother. Her mother also recognized that the cost of maintaining the cottage could be a burden on her two children, so she also left each of them $100,000, specifically to help pay for property taxes, maintenance, and utilities at the cottage.

The problem is that Janice's brother is a spendthrift and blew his $100,000 on other things. Now, Janice is left holding the bag and having to pay for more than her share of the cottage costs.

Her mother could have avoided this problem by setting up an endowment in a trust using the $200,000 she left to help with cottage costs. She could have specified that only the income on the $200,000 could be used to cover costs each year, with Janice and her brother making up the difference if costs are higher than the income earned.

Alternatively, she could have specified that the income on the endowment could be used along with some portion of the capital, or principal, up to some maximum annually. Or, she could have allowed use of the income along with a portion of the principal so long as the principal is used only for major improvements or renovations and not annual operating costs.

The point is, there's flexibility in how you structure an endowment, but it can be a big help to your heirs if you have the means to leave a little to cover some cottage costs.

Tim Cestnick, FCPA, FCA, CPA(IL), CFP, TEP, is an author and founder of WaterStreet Family Offices.