The intergenerational issues associated with a family vacation home should be approached in a similar way to how one would prepare for the succession of a family business, according to a recent white paper published by Merrill Lynch.

The intergenerational issues associated with a family
vacation home should be approached in a similar way to how one would prepare
for the succession of a family business, according to a recent white paper
published by Merrill Lynch’s Private Banking & Investment Group.

As families expand and start thinking about how to preserve
the vacation home as a legacy, one essential step is to create a formal master
plan, Wendy Goffe, a Seattle-based estate attorney, says in Who Gets The Beach
House?

What makes running a family vacation home particularly
complex for wealthy individuals is the emotional attachment involved, the
influence this may have on how the home is managed financially and the
potential conflict among family members over an array of issues - from cleaning
duties to paying the bills.

“One of the biggest things that ultra high net worth
families tackle is governance,” Stacy Allred, wealth strategist within Merrill
Lynch’s Private Banking & Investment Group, told Family Wealth Report.

“The family vacation home is an example of that - with the
added emotion of personal use. It’s a complex asset to govern and much
different than managing a family foundation or portfolio.”

It’s also a place where “unexpected things can happen” and
thus families should protect the asset and themselves with things like
liability insurance and perhaps the formation of an LLC, Allred added.

Importance of disclosure

Many families refrain from sharing sensitive information,
such as matters relating to inheritance, because they don’t want to make the
vacation home or wealth in general a source of conflict or primary focus,
explained Michael Liersch, director of behavioral finance for Merrill Lynch
Wealth Management.

“Often, the patriarch or matriarch, or whoever generated the
wealth, will delay that conversation until they feel that they need to have
it,” Liersch said.

This point ties in with a number of survey findings from US
Trust earlier this year, such as that few wealthy parents believe their
children will be mature enough to handle their wealth before the age of 25. At
the same time, only 39 per cent of parents whose children are aged 25 and above
have fully disclosed their wealth to children, while 53 per cent have disclosed
“just a little” and 8 per cent have disclosed nothing at all.

Allred emphasized the importance for families to talk about
the concept of shared resources and values surrounding issues such as
sustaining wealth and maintaining assets.

She illustrated the risk of holding back important
information by explaining how one with family she worked with previously, the
parents dramatically underplayed the assets the children would receive with
their inheritance, including the vacation home, telling them they shouldn't
expect much. When one of the parents died suddenly, the children were left
“millions of dollars” in trusts, which was hard for these heirs to come to
terms with.

“Those surprises without any experience of what it might be
like to have that type of wealth - and how to sustain and manage it - can lead
to unintended consequences in terms of financial and relationship outcomes,”
Allred said.

Meanwhile, one of the more practical challenges relates to
the funding and upkeep of the home, as maintenance costs can be incredibly
expensive - particularly for those located in riskier areas such as by the sea.

“It’s challenging to maintain these family homes across
generations. One of the biggest rules to lay out is who’s going to contribute
to the maintenance of the house,” Liersch said.

Indeed, in some cases the owners will leave a trust to help
the next gen fund building work, for example – but this will likely dwindle
over time and eventually run out.

Then there is the issue of sibling rivalry, and fairness and
equality. For instance, one family might live in driving distance to the house
and so is able to use it a lot, while other family members on the other side of
the country only use it one or two weeks a year.

“Developing a common set of rules can be a huge way to
overcome behavioral challenges that can lead to conflict in families,” Allred
said.

Liersch added that he and Allred have worked together with
families in reframing the idea of “it’s never too late” to “it’s never too
early” – highlighting the case that engaging on issues such as those related to
the family vacation home is a way of creating family unity.

Plan

As stated in the paper: “The whole point is to create
explicit communication and accountability for things that are going right and
wrong.”

It highlights the need among families for a clear mission
statement outlining what the home means to them, what they see as its long-term
future and how it will be handed down. The latter point is particularly
important and can be handled in several ways.

“The easiest and most straightforward way to hand the house
down is through an outright gift while the owners are still alive,” the paper
says. “It’s relatively easy, inexpensive and requires minimal paper work. There
are potential tax benefits as well.”

Establishing a Qualified Personal Residence Trust with a
term of ten years, for example, removes the house from the grantor’s taxable
estate. However, should the grantor die before the term is up, the house will
revert to his or her taxable estate.

Another option is to transfer ownership to a family
liability company (the main drawback of an outright gift or QPRT is the loss of
control over the house). In this instance, grantors can gift shares in the LLC
and share decision-making if they so wish. Non-voting shares could be
distributed to children, for example, giving them a financial stake but limited
powers.

“Whether you use an outright gift, QPRT, LLC, another trust
vehicle, or some combination of the above, regular annual ‘shareholder
meetings,’ while not a requirement of any of these structures, are strongly
recommended,” Goffe said.

Deciding to sell up

The paper also acknowledges that some families may struggle
to establish an objective view of the “true costs” and benefits involved in
maintaining the vacation home. This, according to Liersch, is due to the
“endowment effect” - the tendency for individuals to inflate the value of
things they own.

However, Liersch has also observed that one of the main
reasons why younger generations decide to sell up is because the property has
become too onerous to maintain.

“In other cases they’ve just transitioned past the home,
they’re more geographically dispersed and the home is no longer a place where
the family comes together or is really connected by it,” he said.

In the end, families will need to weigh the financial
liabilities of a vacation home against their emotional attachment, the paper
says. While this is not necessarily a straightforward task, family
collaboration and preparation can help smooth the decision-making process.