Many estate planning clients have valuable interests in real estate. The planning that CPAs and estate planning attorneys do for them often involves transfers of all or a partial interest in this real estate. Much has been written about the tax planning opportunities for these transfers, especially regarding the discounts available. But this column will focus on what happens after the transfer takes place and suddenly there are co-tenants whose right and responsibilities must be defined.

Take for example, a client who created a Qualified Personal Residence Trust (“QPRT”) that has terminated successfully. The client is happy because she has transferred a valuable asset to her four adult children outright without using much of her gift tax exemption. Now her four children are co-owners of the residential property in a desirable location and each claims that they want to use it from time to time as a vacation home. The deed has been recorded and you are meeting with the children to discuss the ongoing management of the property. The only thing that the four children know they agree on is that they would like to use the property and not sell it.

What Needs to Be Discussed With These New Co-Owners?

It is important that they have a written agreement setting forth their rights and responsibilities as to the property. The simplest way to do this is to enter into a tenants-in-common agreement. The agreement should address the following issues:

1. Use of the Property: Who can use the property — the four co-owners only? Spouses without the co-owner being present? Children? Friends? How much time does each co-owner get? Will there be a schedule? Are there certain popular times of the year to use the property? Will they rotate each year so that each co-owner gets to pick their first choice?

2. Management: One or more of the co-owners will need to be in charge of the budget and operating capital for the properties. Someone will also need to coordinate schedules, maintenance and repairs of the properties. Who will manage this? If it is one of the co-owners, will they be paid a fee?

3. Permitted Transfers: If one of the owners decides to either gift or sell his or her interest to a family member or a non-family member, will that be allowed? Under what conditions? Will the other owners have a right of first refusal if transfers to non-family members are allowed?

4. Death of a Co-Owner: What is a co-owner allowed to do with his or her interest at death? Can it only be left to a family member or could it be left to a non-family member? Does this trigger a right of first refusal?

5. Sale of the property: Under what conditions can the entire property be sold? Do the owners need to have unanimous agreement?

6. Refinance: Does a refinance require unanimous agreement?

7. Financing the Cost of Ownership: Owning residential real property for personal use costs money. How will these costs be paid — property taxes, insurance, routine repairs and how will decisions about reserves and capital improvements be made? Unanimity or majority vote? Will users pay a rental charge for each use? Will this charge vary with the time of year and the desirability of the seasonal use?

The owners also need to keep in mind that this agreement will bind their children as well if they are to own the property in the future. That means that instead of having only four co-owners, the number of co-owners will be much larger and the agreement becomes more unwieldy. One alternative is to put the properties into a LLC, which would provide an easier method for future management and control. For example, a LLC agreement could provide that each of the four families must vote as a block. However, this approach requires the formation of a new entity and annual maintenance fees for the entity. If the co-owners aren’t sure how long they will retain the property, it might not be worth the trouble. On the other hand, if the family views the property as a vacation compound that they would like to maintain for generations to come, it might well be worth it.

Ideally, this agreement should be made as soon as possible — even contemporaneously with the preparation of the gifting document so that expectations and patterns aren’t created that create a roadblock for cooperative planning among the co-owners.

Lara Gilman is a partner in Farella Braun + Martel's Family Wealth Group and counsels individuals and families on estate planning and succession planning.