Most people believe that when they pass on, all of their property, including family homes and cottages, will transfer peacefully to their next of kin. What if I told you it’s not that simple?
We here at Brick & Corbett may be experts in real estate, but we needed to know the law. So, Tommy Corbett and BJ Brick hosted a webinar seeking expert advice from attorney, Mark Kellogg. You can watch the entire conversation unfold by clicking the video link, or read the transcript of that conversation below. Either way, the proactive resources we uncovered will give you the necessary tools to empower in protecting the future of your property’s legacy for many generations to come.
Please note that due to the legal dialogue nature of the text, small edits have been made, and a quick glossary of legal definitions is been provided.
GLOSSARY:
- LEGACY PROPERTY– Any property, including homes or cottages, that is intended to be passed down to future generations.
- FOUNDERS– The initial, or original, property owners.
- TENANTS IN COMMON– This describes an estate that has shared ownership, in which each owner owns a share of the property.
- LIMITED LIABILITY COMPANY (LLC) – A business structure in the US whereby the owners are not personally liable for the company’s debts or liabilities.
- TRUST– An arrangement whereby a person (or a trustee) holds property as its nominal owner for the good of one or more beneficiaries.
- BENEFICIARY– A person who derives advantage from something, especially a trust, will, or life insurance policy.
- UNCAPPING– This means that If a property’s taxes have been capped for a generation or more, the disparity between the taxable value and state equalized value (or SEV) could be quite large, and the property tax bills after uncapping would be significantly higher going forward.
- ENDOWMENT– An income or form of property given or bequeathed to someone.
- CALL OPTION– An option to buy assets at an agreed price on or before a particular date.
- PUT OPTION– An option to sell assets at an agreed price on or before a particular date.
BJ Brick:
Hello, hello. How are you guys doing? Oh, hello. How are you guys doing? This is BJ Brick, and Tommy Corbett with Re/Max Bayshore and Brick & Corbett. We have a special guest with us today, Mark Kellogg, here to talk to us about keeping your cottage in the family for generations to come. Looking forward to chatting with you. Mark how are you doing?
Mark Kellogg:
I’m good, thanks. Good morning to everyone, and I appreciate the opportunity to be here.
BJ Brick:
Absolutely.
Tommy Corbett:
So, Mark, kind of give us the basics here. What do you do? And you’re the author of Saving the Family Cottage, which personally I did read a couple of years ago just because our family was going through something like this. It’s extremely helpful. So, tell us what you do, what your specialty is.
Mark Kellogg:
Yeah. So, I’m not an actual author yet, hopefully that’ll come. So, what I do is, and I’ve been doing this pretty much primarily for the last three years. I’ve been practicing law for 35 years; I hate to admit. But yeah, I discuss with families and I get calls daily pretty much, or emails daily, but will talk to families with second homes, or as I like to call it, “Legacy Property” because I’ve done some with people with farmland as well as cottages and other hunting cabins, so many types of properties. But I talk to families primarily about how to pass their legacy property down through the family and provide counsel, as well as ultimately oftentimes a plan that they will assist in developing and implementing for second properties for cottage planning.
Tommy Corbett:
Awesome. So, can you give us the basic framework for what you recommend?
Mark Kellogg:
Yeah. So, let’s start with cottage ownership and what that might look like. Oftentimes when people initially buy a cottage, I’ll call them the founders, the initial purchasers. And we work with multiple generations from first generation to probably, I have some people fourth and fifth generation. And usually this cottage, as you probably are aware, is the meeting place for the family and it holds a very special place in their hearts. So usually when it’s initially acquired, it’s going to be either joint tenants with rights of survivorship between the owners, or if it gets passed down, tenants in common (TIC). So, what that means is that as it gets down in generations, it gets splintered more in ownership and each owner in that generation owns an undivided interest, or a percentage interest in that property.
Mark Kellogg:
Typically, there’s significant issues in that type of ownership. When I meet with people, they always tell me their kids will get along and there won’t be problems, or say, “there won’t be issues, let them figure it out”-or at least some say that. But this provides a plan where with the tenants in common, you have risks. There are rules out there that people don’t know of, it’s that common law provides the rules and there aren’t rules you would think that would govern co-ownership and property. One of the most significant things a co-owner can do, so they could transfer it to anybody they want, transfer it outside of the family if they choose to do so. One of those significant things they could do though, if there is a major dispute, is bringing a partition action where they could force a sale of the property. So, there’s a number of hazards in these tenants in common ownership with regard to these properties.
Mark Kellogg:
What we would do is develop a structure, and typically it’s a limited liability company (LLC) or a trust that will become the vehicle that will become the owner of the property. And then you have ownership, with the LLC, it’s membership that would be essentially the heirs or as it gets passed down, they become members. And in a trust, you’d have beneficiaries. So, let me briefly mention a big issue in Michigan. It’s the property taxes, and there’s a difference between the taxable value and the assessed value. This started back in 1994 when Proposal A was passed, really focused on school funding, and they adopted this mechanism from California. I don’t know why you’d never adopt something from California, not that I hate California, but I don’t think they’re the best example (to follow. So, it’s Michigan and California that have this dichotomy between taxable value and assess value.
Mark Kellogg:
One of the big issues in Michigan to avoid is what they call uncapping of the property taxes. Various transfers, and I won’t go into a lot of detail, but various transfers can cause an uncapping. And over time, the taxable value- it’s artificially limited to cost-of-living adjustment or up to a maximum of 5%. The assessed value is not. And those with cottages or lakefront property know that the value, especially (when) we had the little downturn, but typically the lakefront property holds its value, and it increases at a higher rate than the cost of living and/or the potential 5% limitation on the taxable value. So, you (then) have a growing gap that occurs. And when there’s an uncapping, they re-adjust the taxable value at the level of the assessed value. Normally that means people with property that has grown in value significantly are going to pay higher taxes when an uncapping event occurs.
Mark Kellogg:
So, in my planning, right now under the current law, you can transfer it to various relatives and avoid uncapping. With regard to the entity structure, LLC versus a trust, with regard to the LLC, an uncapping event will occur when there’s a transfer of greater than 50% interest of the members in the LLC. So, if you look at it that the first generation owns 100%, when they transfer that down to the second generation, inevitably it’s going to be a greater than 50% transfer if they’re going to transfer 100% down to generation two, let’s call it, and an uncapping will occur. With regard to trust, the current laws allow you to transfer beneficial interests at least down two generations and maintain the cap to value because there’s a specific exemption for it. So that’s kind of a big decision in using an LLC or a trust in the planning.
Mark Kellogg:
So, that’s kind of a basic discussion I have with all of my clients at the very beginning. So, then we create the structure. And so, think about anything that happens or that you need to deal with when you own property with somebody. Number one, who should own it? I’d say 99.9% of my clients say they want it kept in the family, so usually the lineal descendants of the founder. So, we provide for that. We limit the ability of any transfers outside of the blood family, so to speak, or the lineal family of the founders.
Mark Kellogg:
Another issue, how has it managed? Who’s the decision makers? So, we set up a structure in developing who makes decisions with regard to the cottage, or the property that’s in this entity structure.
Mark Kellogg:
As you can imagine, as you get down more generations, the members can grow tremendously. I’ve worked with a family with property up in Canada…they have over a hundred potential, what would be members, or beneficiaries of a trust.
Mark Kellogg:
You don’t want, necessarily, a hundred people trying to make decisions. Normally we have a subset of that membership who are the decision makers. In our documents and agreements, we call that the management committee. It would either be the managers in the LLC, or trustees in the trust. So, it will be a subset of the owners that will be the decision-makers, usually with regard to the more day-to-day type decisions.
Mark Kellogg:
More significant decisions we would typically let the members, or I’ll call them owners, let them have input or decision-making ability for some of the major decisions. But normally, the day-to-day things, you set up a management committee that will make those decisions.
Mark Kellogg:
Again, as we plan, and as you’re setting up a succession plan, you try to provide for transition down generations. You set it up in a way that it continues, and the agreement provides for a way for it to continue. So, within this management committee, how do you decide who sits on that board?
Mark Kellogg:
Oftentimes we do it in what we call branches. So, each branch has a representative. Again, let’s say there’s the founders and let’s say they have their four kids, when it gets transferred down to generation two. So, you might now establish four branches. And as it gets passed down to generation three, you maintain that four-branch kind of structure. Now you’re always going to have four members sitting on this management committee. And each branch; a lineal branch, is represented on that committee.
Mark Kellogg:
I’ll stop there. I don’t know if there’s questions that you have with regard to any of that? I can continue on to some more of the things that we try to deal with in these agreements. Any questions?
Tommy Corbett:
I have a question and I would like you to continue down that line, because I think that’s what’s so interesting about what you do. My question was, the uncapping, or the ability to set it up so it doesn’t uncap when you pass it down generation to generation. Does that apply to both commercial and residential property in the state?
Mark Kellogg:
That’s a great question, Tommy. I’m glad you brought that up. In the statute itself, it only applies to residential property.
Tommy Corbett:
Okay.
Mark Kellogg:
And another significant aspect of that, they define what residential property is, in this particular statute. And they say, if you rent the property more than 14 days, then it’s taken out of the classification of residential property.
Mark Kellogg:
Those who want to rent the cottage, which happens frequently, they may not qualify for that exemption, so I’m glad you brought that up, because that’s a significant piece of that uncapping law. And it has to be residential property.
Tommy Corbett:
Yeah. Okay.
Mark Kellogg:
Other considerations, as you’re looking at the structure and how you put things together, a big issue is cost. How do you pay for it? Oftentimes, we will have founders, or someone and some generations, who have the financial wherewithal where they might create an endowment. That makes it much easier.
Mark Kellogg:
Our agreements would deal with an endowment, what you can use it for, and those kinds of things. That can either be part of the existing operating agreement or the trust. Or sometimes people will have it in a separate entity or structure.
Mark Kellogg:
But if you have that endowment, again, it makes it easier, at least for a period of time, as long as the endowment lasts. With regard to the cost, how is that allocated? Most people that I’ve worked with, again, do it in this branch structure, so in the branches.
Mark Kellogg:
But that might be a little different than individuals, because you may have more than, different individuals, depending on how many kids people have within each branch. So, the allocation may not be equal across individuals, but oftentimes equal among branches.
Mark Kellogg:
But those are part of the decision-making that my clients will make as we develop this plan, or what do they want it to look like?
Mark Kellogg:
The other thing about a plan, a kind of succession plan is, what if people don’t pay the cost? You’re dealing with, maybe brothers and sisters, you’re dealing with cousins, you’re dealing with family, right? We will oftentimes set up potential sanctions that deal with it if someone doesn’t contribute, and can’t pay their fair share, or won’t be there for fair share.
Mark Kellogg:
And that can range essentially from a late payment fee, maybe take away usage, maybe they can’t be part of the management. And the ultimate hammer in getting people to pay is what we call a call option, this is where the company or the trust has the ability to buy those people out.
Mark Kellogg:
You guys deal in real estate, so it’s a fundamental tension. The seller wants as much money as they can get, the buyer wants to pay as little as they can.
Mark Kellogg:
So, whenever you are dealing with these types of properties, the founders, or whatever generation, has set this up because they want to keep it in the family. So, they’re willing to pay this additional cost and go through this planning process because their intent is to keep it in the family.
Mark Kellogg:
So oftentimes our agreements will have a formula built in, on a buyout. So, in this call option situation, how do you determine the price or the value of the property? Oftentimes, we’ll have a discount applied. Because the desire is to make it less burdensome on those who want to keep it in the family, because that’s the intent. And they’re going to probably either have to come up with the money, unless they have some other, again, an endowment that might be available, or something else. They’re probably going to have to pitch in and come up with the money to pay for it.
Mark Kellogg:
You might oftentimes apply discount to the value to make it easier for them to do that. And then, more often than not, we provide a time period in which they can pay this exiting owner. Some people probably range from five years to, I’ve had some go 30 years, which probably is a little long. But again, that reflects the desire to make it a doable thing to buy somebody out if they want out.
Mark Kellogg:
And I think it’s important, again, when you’re dealing with family, to have an exit strategy, to let someone have a graceful exit and maybe still get value.
Mark Kellogg:
There are two ways that people look at this, and that’s where you run into this tension, is it a resource to be used by your family and multiple generations to come? Or is it an asset to cash in on? And at some point, in the generations, you’re going to have somebody see it as an asset to cash in on.
Mark Kellogg:
There some a very valuable properties, and I know in your area, Traverse City, there are very valuable properties. And not everybody may want to use the cottage, or maybe they live somewhere else and don’t use it.
Mark Kellogg:
So, we also have what we call a put option in our agreements. Similar concept, although it’s a voluntary give-back, let’s say, where the owner says, “Listen, I’m not going to use it. I live in California; I live in New York. I’m not going to be here. I don’t want to pay towards it.” So again, you provide a mechanism and a formula to determine what the payout would be if someone just says, “Take me out, I appreciate it, but I don’t want to be part of the thing.”
Mark Kellogg:
Again, so you develop a formula within there, with a potential discount, with an ability to pay over time, that would make it as least burdensome as you can for those staying behind to have to finance that buy out.
Tommy Corbett:
What’s a typical discount, or what’s a discount that you recommend?
Mark Kellogg:
Probably the most typical (discount) would be between 10 and 25%. I have some clients who will go up to 50%. And I actually have a few, and this hasn’t been tested, at least not by me and Court yet, if there’s an issue or if something comes up, would just say, “they don’t want anybody to get anything out of it”. So, if they want out, you walk away, and that’s it. Because their feeling is, again, as you get down further generations, they say, “Well, I didn’t have to pay for it, and I’m not going to give you money to walk away, because you’re not having to pay for it.”
Mark Kellogg:
So, there’s a strong sentiment for that. But, so most discounts, I would say, if you look at the average, probably between 10 and 25%.
Tommy Corbett:
Yeah. So, we got a question, and my wife is sitting next to me so she’s going to hate this, but it’s not my question. How would a divorce affect a succession plan?
Mark Kellogg:
Yeah, that’s a great question. So, what you have, again, we kind of build in protective language in the agreement that deals (with that). So, remember, first and foremost, it depends on where the divorce occurs. But if it’s down another generation, let’s say generation two, we already have built in that a surviving spouse doesn’t ever get ownership rights. So, it stays in the family, it can’t be transferred to a spouse.
Mark Kellogg:
But in a divorce situation, you always have the issue of, “well, there’s value there”. There’s value in that interest. And how can I get it when someone is divorcing, how can I get some of that value?
Mark Kellogg:
Fundamentally, under the law, normally an inheritance is not considered part of the 50/50 deal that we think about when someone’s going through a divorce. So, there’s that benefit. But we also put language in there to try to limit the ability of a divorced spouse to have any rights to it or to be able to try to force any kind of rights to it. They can never own it. That’s prohibited in the agreement that everyone is signed up under.
Mark Kellogg:
So again, we build that in. The bigger issue often times is what happens to the surviving spouse? Again, not the family that’s in the family line, but the surviving spouse of an owner. And so, that initiates very interesting discussions at times of whether a surviving spouse can use like the deceased owner, or who makes that decision? So that becomes even a more difficult discussion. And the surviving spouse, would be, that they’re married at the time the owner passes. So, they’ve been married the whole time, and now you’ve got this cottage that he or she’s been part of, that she’s used, that their kids have used. What happens in that situation? So that’s another aspect of an agreement that we’ll go through with our clients and try to deal with in the agreement itself.
Tommy Corbett:
Yeah. So, we had somebody ask, “what are the biggest mistakes you’ve seen families see in regard to passing down homes or cottages?”
Mark Kellogg:
Well, this might be a bit self-serving, but the biggest is not making a plan. So that’s kind of what I’m here for, is to encourage people to make a plan. So, I’d say the number one mistake is just not to do anything. And I have had people who I’ve talked to, and they say, “You know what? I’m going to be gone. I won’t know what’s going on. My kids can take care of that.” So that is an option. That is a (type of) planning option: don’t plan. That would be the biggest (mistake).
Mark Kellogg:
As far as planning itself, I’ve walked through some of these aspects, and I think you really need to consider how these (decisions) impact the family and try to make it as fair and equitable as possible as you walk through each of these issues that I’ve been talking about here.
Tommy Corbett:
Yeah. What are some of the common disputes? Say we planned, and you’ve got the limited liability entity set up or the trust, and now it’s in generation two or three. What are some of the disputes that come up?
Mark Kellogg:
Yeah. So, I haven’t dealt a lot with that yet, the generations, and I don’t know how many generations I’ll end up having to work with. But one (common dispute) is the value. If people want out, what do they get for it? And remember, a lot of these are inheritances, and whether you think it’s correct or not, people think they’re entitled to an inheritance. So, the cottage is part of that inheritance. And sometimes, again, a very valuable piece of property.
Mark Kellogg:
So that becomes an issue if someone does want out. “Well, I didn’t get my share of this, or my share of that inheritance property, but you guys still get to use it.” I’d say that’s probably one of the bigger issues. The other issue potentially is, as you develop rules and procedures for the cottage, whether everybody agrees with them or not. I don’t often times go into the specific, very detailed rules of usage and that kind of thing.
Tommy Corbett:
Things like, “clean up the kitchen.”
Mark Kellogg:
But that could also be an issue, too.
Tommy Corbett:
Or, “Clean up the beach.”
BJ Brick:
You’re cleaning up the kitchen, Tommy. (laughter)
Tommy Corbett:
Yeah. You left a mess in there, BJ.
Tommy Corbett:
The thing I could really see, one of those more like by law type rules and regulation things that would come up, would be just setting the expenses needed, you know? Like, “everyone has to contribute this much every year” (structure). Tell us how you determine that, or… do you help with that? Or is that someone else?
Mark Kellogg:
Well, we can certainly assist with that. I think in that regard, the bigger issue is that some people want to do improvements, but they don’t all agree on improvements. Those (issues) become, I think, significant issues (that benefit from) an agreement on that kind of thing. Those who can afford it may say, “Well, let’s do it.” Others who can’t (afford it) may not want to throw that kind of money at the cottage.
Mark Kellogg:
So, in talking about the structure, and who makes those decisions, often times on improvements we drop that decision broader to the whole ownership class (or group) than the management committee. So again, some of those kinds of decisions, we let everybody participate in and potentially vote on that if they (decide to) take a vote.
Mark Kellogg:
So, I would say that’s probably a significant kind of issue…
Mark Kellogg:
And that kind of major outlays that could happen. Do we rent it? That could be an issue. Some people prohibit renting completely and they say, “Nope, we’ve never rented it. We aren’t going to rent it.” That might be short-sighted (or it might not be). But I will tell you, any of these agreements can typically be amended. It may (however) take a super majority or larger group to amend it. So, you don’t want to tie their hands completely so they can’t do some things that you didn’t foresee down the road. The rental thing, at some point it may be expensive enough where you rent it to pay the expenses and you just take the consequences of renting it. So that potentially can be another kind of controversial issue on the rental piece of things.
Tommy Corbett:
Yeah. Well, so you…you set up these agreements and then, do you kind of like follow it along?
Mark Kellogg:
I do, yes.
Tommy Corbett:
Yeah. So, I guess this isn’t a particularly legal question, but I don’t get to talk to people in your area of expertise too often. What are some characteristics that you see in families that are particularly successful in a succession plan?
Mark Kellogg:
Right. Well, so number one, I think from the start they’d need to be on the same page that they want to develop a plan. (Recently) I had a family of three come into my office that I hadn’t met before. And so, we all sat down, and we were looking at developing a plan when one of them (abruptly) says, “Well, I want out.” And the other two said, “Well, we can’t pay you to get out.” And so, I said, “Listen, you guys need to come to an agreement on how you’re going to do this before you pay me money to develop a plan. It’s not going to work if you fundamentally (disagree and) enter into an agreement on this right now.” So, they left. I told them to go and figure it out.
Mark Kellogg:
I haven’t heard from them since, so I don’t know where they’re at with trying to make that decision. But number one, I think they all have to agree that it makes sense to make an agreement (to begin with), and (agree that) they’re committed to taking the time and putting in the effort to make as good of an agreement as they can. I think that’s the number one, fundamental thing before even entering into this process.
Mark Kellogg:
I do think it makes it much easier if the founders are in a position to do an endowment. So obviously that makes it easier when you aren’t having to put money in, if people can just show up when they want and it’s not a cost burden on them. That certainly, I think, makes a big difference on some of the decision making in what things look like. And usage can be an issue too. It depends on how big some of these cottages are. They aren’t what some people would consider cottages, some there are more like homes that can accommodate a lot of people. Some are truly small cottages and they kind of retain that (cottage) feature. And so, you’ve got to do scheduling (time) in a fair and non-committal way.
Mark Kellogg:
As you know in Michigan, there’s a finite period of (prime) time from, let’s say, Memorial Day to Labor Day. And that’s your prime season typically so you’ve got to break it up in a way (that is fair to all). It’s (usually) easy at the founders’ level, or even the next generation, because you’re dealing with limited amount of people. But as those owners grow and you’re going down multiple generations, that could become a bigger issue.
BJ Brick:
This is really interesting stuff. Honestly, the need (for this information) is there for a lot of people. I have personal friends that are going through this situation right now, and I know that they employed an attorney for some advice. And now I’m really glad that they did because it’s pretty complex when you really break it down.
Mark Kellogg:
Well, it can be. It just helps talking this through with people, the different issues that they might not be thinking about. And more often than not, I’ll get the question, “well, what do you suggest? What do you recommend? What have you seen that works?” And so, having some experience and putting these together and Tommy, lust like some of the questions you’ve asked…I’d ask, “Okay, what doesn’t work or what’s been the impediment to some of this?” It helps toward guiding them in how they will make their decisions, as well as the types of decisions they make setting these plans up.
Mark Kellogg:
Because certainly, the intent is that the (cottage or home) will last multiple generations. That’s what everybody wants. But it does take some agreement, right? It’s people working together, and you always hope that families can figure it out and, and work out differences, because there are always going to be some. But what we do is say, “Okay, we would like everyone to agree. But if you don’t, we have a management structure and/or a voting structure that will carry the day if it really comes down to a vote like that in the end.” Then they’re all bound by it. They’ve all agreed to follow this agreement.
BJ Brick:
Well, great stuff. I’m sure that just this dialogue is helping a lot of people start thinking through some of the questions they need to have answered. It’s kind of amazing what’s happening up in our area, and there’s quite a few second-home cottages being acquired as we speak. It’s worth thinking through the options, the LLC versus trust, and then just down the whole path of a spider web of potential hang-ups that could happen in the near future.
Mark Kellogg:
People with businesses have succession plans if they want to keep it in the family. And this type of property can be very valuable, or it may even be the most valuable asset that a family hold. So, they will probably want to do some planning like you’d do for your estate plan. You might do some business succession planning. If you have a valuable second home like this, it makes sense to do some planning and think about what you want with regard to that. I mean, selling is always an option, but that’s not typically the client I normally work with. It’s just not typically the case. There is a strong, emotional attachment and a feeling towards these types of properties, so it lends itself to people thinking about those kinds of things.
Tommy Corbett:
Absolutely. We greatly appreciated your time, Mark. And I’m sure we’ll run into some of these questions, and we’ll make sure to turn them onto you.
Mark Kellogg:
Yeah, let me know if I can help and I appreciate, again, the opportunity and looking forward to summer getting here sooner rather than later, I hope.
BJ Brick:
All right. Thanks so much, Mark!
If you have any questions about protecting you legacy property, or about buying and selling your home, Brick & Corbett are here to help. With over 60 years of combined real estate experience we know the market inside and out.
Thank you to our expert guest, Mark Kellogg