Wisconsin summers invite many enjoyable activities: boating, hiking, fishing, and of course, trips to the family cabin. A hallmark of Wisconsin’s Northwoods, the family cabin, is a treasured piece of Wisconsin culture. Its foundation tells the story of a family’s hard work, close bond, and dedication. Families gather, laughter is shared, and memories are made.
It is no surprise that the cabin is often a family’s most valuable asset. As such, protecting it from devastating long-term care costs requires special attention and advance planning. Considering the unique nature of family-owned real estate like cabins and farms, a family LLC may be a more efficient and manageable asset protection vehicle to operate and protect family property.
Benefits of a Family LLC
One of the greatest advantages of a family LLC is the level of control afforded to family members, particularly members preparing for long-term care.
When placing assets into trust, the grantor must not be able to have access to or control over the principal (otherwise it is deemed a countable asset for Medicaid).
In contrast, the family LLC, by allotting membership interests, gives significant control to an owner preparing for long-term care. The family LLC, like any other LLC, has an operating agreement that provides for cost-sharing, membership allocation, and operation.
Considerations When Setting Up the Family LLC
Functionally, the family LLC works best when there are at least two children (or other members), and you know that one of the members will vote with your client. The key is to give your client sufficient interest to always cast the tie-breaking vote if the operating agreement provides for majority voting.
In a family of four, the membership interests would be as follows: child 1 has a 49% interest; child 2 has a 49% interest; mom has a 1% interest; and dad has a 1% interest. If at least one child will predictably vote with mom and dad, mom and dad maintain significant control over the asset while minimizing the membership interest that would be deemed an available asset.
The five-year look-back period begins when the 98% membership interest is transferred. Once the five-year look-back period passes, the interest subject to nursing home care costs for mom and dad is at most 2%. In the event mom or dad need to go to the nursing home, the other LLC members may purchase the remaining 2% interest for fair market value.
One disadvantage of most asset protection vehicles is that they preclude heirs or beneficiaries from receiving a step-up in tax basis upon the death of the grantor. This results in significant capital gains taxes on property that has been in the family for a long time if the family sells it. Special consideration must be given to the length of time the family will realistically hold and use the asset.
Nevertheless, Section 2036 of the Internal Revenue Code offers one mechanism for receiving a step-up in cost basis: a retained life estate. If, for example, mom places the cabin in a family LLC and retains a life estate, upon her death, the family receives a step-up in the cost basis as to the fair market value of the cabin on her date of death.
The caveat, however, is that a life estate created on or after Aug. 1, 2014 is subject to estate recovery.1 Thus, a greater portion than her 1% interest would be at stake. In situations where children are unsure whether they will sell property with a low cost basis in the future, then it may be more advantageous to use the life estate to obtain the step-up in the cost basis with the understanding that mom’s life estate may be subject to estate recovery if any long-term care is required.
Why Not Use an Irrevocable Cabin Trust?
In circumstances where a client owns an important piece of family real property that he or she wishes to protect, an irrevocable trust is a logical solution.
But it has disadvantages. In the case of the family cabin, transferring the property into an irrevocable cabin trust initiates the five-year look-back period for Medicaid qualification. However, control over the property is ceded to a trustee or trustees, thus long-term operating flexibility is lost, and family decision-making is largely cast aside.
Because the family is often protecting the property for long-term use, the administrative burdens and restrictions of holding the property in trust may be counterproductive.
Conclusion: A Family LLC Offer Options
There is no “one size fits all” solution to asset protection planning. However, in the case of important single-asset family property, family LLCs provide flexibility and options.
Family LLCs give families greater autonomy to make decisions and affords members concerned about long-term care costs the opportunity to participate while also protecting the asset.
This article was originally published on the State Bar of Wisconsin’s Elder Law and Special Needs Blog. Visit the State Bar sections or the Elder Law and Special Needs Section webpages to learn more about the benefits of section membership.
1 See the Medicaid Eligibility Handbook, Table 39.1: Life Estate and Remainder Interest, for the ownership interest attached to a life estate.